ECB Extends Refinancing Operations, Raises Growth and Inflation Outlooks

At today's ECB meeting, President Trichet announced to provide unlimited liquidity at least until mid-January 2010 while leaving the main refinancing rate unchanged at 1% for a 17th month. Meanwhile, ECB economists raised GDP growth and inflation forecasts for 2010 and 2011, providing a more upbeat outlook for the 16-nation region.

Inline with our expectation, the ECB extended the full allotment procedure for the 1-month MRO and the 1-month special-term operations at fixed rates for 'as long as necessary' and at least until January 2011. The central bank will also provide 4 3-month LTROs (in September, October, November and December) with full allotment at rates fixed 'at the average rate of the MROs over the life of the respective LTRO'. The Governing Council has also decided to carry out 3 additional 'fine-tuning' operations at the end of September, on November 11 and on December 23 when the remaining 6-month and 12-month refinancing operations mature. In our opinion, the aim of the measure is to smooth over the expiry of the refinancing operations and to ensure sufficient liquidity is provided. Similar smoothing measure was done in July when the 12-month LTRO worth 442B euro (expired on July 1) was replaced by a 3-month LTRO and a 6-day tender.

The decision to link the rate in the 4 3-month LTROs to the average rate of the MROs raised questions about whether the ECB has planned to normalize the unconventional measures from mid-January next year. Some analysts asked during the press conference whether the ECB has hoped to hike the policy rate by 1Q11. Regarding the issue, Trichet stressed that policymakers are 'in a process' of exiting non-conventional measures and they 'have no intention to signal any intention of interest rates at this point'. We expect the ECB to leave the policy rate unchanged in 1H11 and hence do not view a hike at 1Q11 likely.

The new set of economic forecasts was striking as both growth and inflation outlooks were raised. GDP projections have been revised up to +1.6% for 2010 (June's projection: +1%) to +1.4% for 2011 (June's projection: +1.2%). While the upward for this year is mainly to reflect the stronger-than-expected GDP growth 1Q10, the upward revision for 2011 mainly reflects, according to the President, 'carryover effects' from stronger growth in late 2010.

HICP projections for 2010 and 2011 were revised up to +1.6% (June's projection: +1.5%) and +1.7% (June's projection: +1.6%) respectively, hinged 'largely on account of higher commodity prices'.

Notwithstanding the upgrades, the ECB emphasized that the risks to this improved economic outlook are 'slightly tilted to the downside, with uncertainty still prevailing' while inflation for 2011 should remain 'moderate' and 'expectations over the medium to longer term continue to be firmly anchored in line with the Governing Council's aim of keeping inflation rates below, but close to, 2% over the medium term'.