ECB Preview: Less about Tightening, More about Greece

The ECB is expected to keep the main refinancing rate unchanged at 1% in January. After announcing some liquidity withdrawal measures at the December meeting, the upcoming meeting will likely be a quiet one. President Trichet should describe current interest rates as 'appropriate' and the outlook for growth and inflation 'moderate' with 'broadly balanced' risks to both sides. As Greece is currently preparing the stability program to reduce budget deficit, we expect this will be the focus of the press conference today.

At the December meeting, the ECB announced that the rate in the last 12-month longer-term refinancing operation (allotted on 16 December 2009) would be fixed at the average minimum bid rate of the MROs over the life of this operation. This decision increased the uncertainty of the cost of funds in the December repo as it would be determined by the strip of ECB repo rates over the next year. As a result, many banks may seek funding in the market instead of the ECB. Moreover, the 6-month longer-term refinancing operation on 31 March 2010 will be the last one.

These measures indicated the ECB is trying to drain excess liquidity it provided to the market over the past 2 year. However, Trichet tried to convince the market that the central bank has not yet started tightening. In other words, the ECB is trying to separate liquidity management from monetary tightening.

In Greece, the government will complete a plan to reduce the budget deficit from 12% to within 3% by the end of 2012. The country's credit ratings were downgraded by S&P and Fitch last month amid worries about its ability to repay the debts. The European Commission (EC) said that there are 'severe irregularities' in the data, indicating the deficit and debt figures may be revised further (downward).

According to the EC report, 'the data have not been validated by Eurostat and a substantial number of unanswered questions and pending issues still remain in some key areas, such as social security funds, hospital arrears, and transactions between government and public enterprises…These questions will need to be resolved, and it cannot be excluded that this will lead to further revisions of Greek government deficit and debt data particularly for 2008, but possibly also for previous years'.

Although Greece is only a small economy in the 16-nation Eurozone, its debt issue unveiled that its counterparts, such as Spain and Italy, may be facing similar problem. We expect many questions regarding economic growth and potential bailout of Greece at the press conference.

Concerning exchange rate, the ECB may reiterate the strong dollar rhetoric but the tone may be 'softer' than before as the euro have weakened around -4% from 2009-peak.