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Today, the European Central Bank closes out a remarkable year.On July 26, ECB President Mario Draghi set the tone for the rest of 2012 when he told the world, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
In August, the ECB followed through on that promise with the introduction of a new bond market intervention program dubbed “Outright Monetary Transactions,” or OMT, designed to remove the “convertibility risk” premium the central bank saw reflected in the spiking sovereign bond yields of the beleaguered nations on the euro area periphery.
These mere pronunciations have sent borrowing costs for those countries decisively lower, and the ECB hasn’t even had to actually purchase a single bond:
[credit provider=”Bloomberg, Business Insider”]
In other words, there isn’t much pressure on the central bank at the moment, and you can bet Mario Draghi is feeling pretty good about that.
Interest rate predictions
As for today, 55 of the 61 economists polled by Bloomberg expect no change to the benchmark refinancing rate from tomorrow’s interest rate decision, which currently stands at 0.75 per cent. And of the 35 economists who sent in predictions on the deposit rate, which currently stands at 0.00 per cent, the result was unanimous: no change.
However, the ECB will also release updated macroeconomic forecasts at today’s meeting, and given a continued string of weak eurozone economic data, the central bank’s staff projections are subject to significant downgrades.
Morgan Stanley is among the six that went against the consensus and predicted that the ECB will lower the refi rate to 0.50 per cent today. The bank’s economists also say the ECB will cut the deposit rate, taking it negative for the first time ever.
Below is the explanation given to Morgan Stanley’s clients:
On balance, we continue to think that the ECB will cut its key interest rates at the December meeting by 25 bp. If our forecast turns out to be correct, this would take the deposit rate into negative territory for the first time in ECB history. We acknowledge that the risks to our out of consensus call are material. Indeed, we see a risk that the ECB might prefer to wait until 1Q to execute this unprecedented step in the light of potential operational considerations ahead of year-end. But we believe that the ECB cannot ignore again what will likely be another significant downward revision to its staff’s growth projections for 2013 without seriously contemplating taking fresh policy measures.
Given that the deposit rate is the more relevant rate for money markets in the current environment, cutting only the refi would run the risk of being ineffective. Breaking through the zero-bound is more pressing for the ECB than for other central banks, we think, given that the strong commitment to OMT has likely increased the hurdles to full-blown QE. Back in September the Council was clearly focused on designing OMT. But this has been done now and the cumulative downward revision in the staff projection for 2013 GDP since the summer of around one percentage point on our estimate (bringing 2013 GDP growth to zero) as well as the muted inflation projection for 2014 should be sufficient to tip the balance towards a rate cut.
Citi economists, who have long expected the ECB to put off cuts to interest rates until today’s meeting, have recently backed away from their call. In a note issued after the ECB’s November meeting, Citi wrote, “Given the tone of the press statement and the improvement in market conditions, our economists indicate that a rate cut in December – while still possible – is now less likely.”
Instead, like many others, Citi expects further rate cuts to be postponed until sometime in the first quarter of 2013.
Greek buyback deal
The other hot topic at today’s meeting will be the ECB’s take on the recent deal among EU authorities to effectively grant Greece another bailout by extending the repayment timeline and lowering the interest rate on previously issued loans to the insolvent country.
Deutsche Bank economist Gilles Moec explains how the ECB fits into the deal:
The ECB is involved (indirectly) in the new financing modalities via the contribution of “income on the SMP portfolio” – more specifically, member states commit to paying into the Greek segregated account an amount equivalent to the income on the Greek portion of the SMP portfolio from 2013 (ECB profits in any case accrue to the national central banks which in turn is payable to national governments).
However, the details are unclear. Reuters correspondent Eva Kuehnen confirms that the Greek deal should be high on the agenda:
A euro zone central bank source told Reuters the Governing Council would also discuss a possible rollover of Greek debt held by some national central bank in their investment portfolios…Asked whether the issue would be discussed on Thursday, the source said “definitely”.
While it was up to the individual national central banks to decide to replace the Greek bonds they hold with new Greek paper as the debt matures, the Governing Council would likely agree on a common line on Thursday, the source said.
The ECB announces interest rates today at 7:45 AM ET, followed by a press conference and subsequent Q&A session at 8:30. We will have LIVE coverage on Money Game >