ECB: No Urgent Needs to Tighten as Growth Seems to have Slowed Down

The ECB will most likely announce to keep the main-refinancing rate at 1% at the meeting Thursday. Although economic recovery remains on track, there have been signs showing that the growth is losing steam. Therefore, there's no urgent need for the central bank to unwind its policies other than the non- standard ones.

The Eurozone exited recession in 3Q09 with a GDP growth of +0.4% qoq after contraction since 2Q09. Expansion in economic activities has been brought about by the government's loose monetary and fiscal measures. However, indicators released recently showed that the region's growth has been losing momentum. In January, the composite PMI for activities, although staying in expansionary territory, dropped for the first time in a year to 53.6.

Inflationary pressure remains subdued this year. Headline CPI rose +0.9% yoy, the fastest pace in 10 months, in December as the negative base effect from oil price diminished. Moreover, stimulus measures also helped lift domestic demand. However, output gap and low labor cost will continue to suppress price level in the medium-term. ECB members anticipate inflation will only approach but stay below the 2% target in 2011.

At previous ECB meetings as well as January's monthly bulletin, policymakers addressed gradual phase-out of non-standard measures. According to the ECB, the last one-year operation was conducted in December 2009, one final six-month operation will be conducted in March 2010, and the number of three-month operations is being reduced as of the first quarter of 2010. The central bank believes that as ‘past reductions in the ECB's key policy rates are increasingly being reflected in the interest rates on bank loans to households and corporations, indicating that the transmission process is broadly functioning', ‘the gradual phasing-out of some non-standard measures is not expected to have a negative impact on financing conditions'. We expect the ECB will reiterate the same stance and the last full allotment procedure may be ending in April.

That said, whether the central bank end the full allotment program also depends on evolvement of the Greek issue. The market has been worrying about the spread of fiscal problems in Greece to other European economies. It that's the case, banks and financial markets in the Eurozone will get hurt and non-standard measures may longer to be unwound.

The Greek issue will once again be a hot topic at the press conference. While Trichet is unlikely to give much comment about Greece's 3-year deficit-reduction plan, he will stress that the ECB is not the institution to deal with Greece's fiscal problems but Greece and other members should implement structural reforms as soon as possible.