Second guessing the ECB has always been notoriously difficult, as the central bank often disappoints investors and commentators with its inaction, but then surprises them with potent hammer blows of definitive action.
However, after last month’s press conference post the regular monthly meeting, the ECB has teed this meeting up to be one of action.
The question is how much action and what are markets pricing in already?
The range of actions that have been tossed about by the market is really very broad, including:-
- A refinancing rate cut
- A deposit rate cut (into negative rates territory)
- Additional liquidity through another round of LTROs
- An asset backed securities purchase programme
- Direct purchasing of EU sovereign debt
- Various direct and indirect lending programmes to SME’s
The upshot of all this talk over the last month has resulted in further convergence of peripheral bond spreads, lower core government yields (within just a few basis points of their all time lows) as well as the continued hunt for yield.
We at TwentyFour were becoming slightly concerned that the market was just expecting too much from the ECB and that a number of these actions were just not likely at this time. Then we had a mini peripheral sell-off last week, which we think rebalanced the market levels along with more realistic expectations. However listening to various ECB governing council members over the last week has also prompted us to revise upwards what we are now expecting them to do on Thursday.
The likelihood of each scenario
Repo rate cut: We think this is highly likely as it is the ECB’s primary tool, but may be only a small adjustment.
Deposit rate cut: This is also likely, with any cut taking the rate into negative territory. This could result in all deposits being moved from the ECB, with the cash being deployed mainly in short-dated government bonds and certain high quality securitisations. It should also serve to reverse the upward trend of the euro.
LTRO: If it takes the same form as before it will serve no material purpose, as banks already have unlimited liquidity. However, a targeted LTRO programme – such as the UK’s Funding for Lending, focused on lending to areas the ECB feels are being restricted – could be a very smart idea and easily implemented. This is somewhat of a wild card, but one that we think has merit.
Direct purchasing of ABS: We think the ECB is determined to support the market, but buying securities directly at this time should not be its starting point. Working with regulators on risk weightings would have longer-term benefits. However, we would not be surprised to hear about some sort of future programme, possibly targeted at small and medium-sized enterprises where the ECB could assist banks to make additional advances to the cash starved sector.
Other quantitative easing: We think this is still some way off, although it is quite possible – hence, we were becoming concerned that this was becoming priced in to any extent.