ECB Meeting: A Slow Normalisation

The ECB's weekly main refinancing operations and the one-month auctions will continue to be with full allotment at least until 12 October 2010. That the ECB promised to give full allotment for such a long period was today's big surprise. For the three-month auctions the ECB is moving to fixed allotment.
The last 6-month auction will be at a rate indexed to the refinancing rate. This will not matter much though, as the refinancing rate is expected to remain unchanged for at least 6 months.
The ECB's assessment of the economic situation continues to become slightly more positive and Trichet emphasised that the current poor data is partly due to bad weather. Nevertheless, we still find that the ECB is too downbeat and we expect further upward revisions in June.
The ECB expects inflationary pressures to be low. In their inflation projection, the upper end of their band for 2011 is nevertheless 2.1 %. They will not have to revise inflation expectations much upward before they can defend to move away from record low interest rates.
The ECB is determined to move towards the exit, but at a slow pace. We expect that the ECB will move to fixed allotment at the one-month auctions in October and for the main refinancing rates at end-2010 at the latest (most likely in October too).
The market reaction was for rates to rise 2-3bps higher across the curve. This may partly be driven by good US initial jobless claims coming out at 14:30.

The ECB is heading towards the exit at a slow pace

The 3-month auctions will be with fixed allotment from now on. The ECB's weekly main refinancing operations and the one-month auctions will continue to be with full allotment at least until 12 October 2010. It was a surprise that the ECB gave a promise for such a long period. It will reduce demand at the final six-month auction. We expect that the ECB will move to fixed allotment at the one-month auctions in October and for the main refinancing rates at end-2010 at the latest (most likely in October too). The ECB will then be back to its normal set-up.

The rate in the last 6-month longer-term refinancing operation, to be allotted at the end of March, will be fixed at the average minimum bid rate of the MROs over the life of this operation as was the last 12-months auction in December. This will not matter much though, as the refinancing rate is expected to be a flat 1% for at least 6 months. The ECB sees the indexation as a way not to signal any rate expectations.

The ECB growth projections a bit more positive

The ECB's assessment of the economic situation continues to become more positive although at a very slow pace. The ECB mid-range growth estimate was unchanged at 0.8% in 2010 and they now project growth of 1.5% in 2011 up from 1.2% in December. The unchanged estimate for 2010 reflects the negative base effect of tiny growth in Q4 2009 and bad weather in Q1 2010, combined with a more positive outlook for the rest of 2010. The more positive assessment for 2011 is driven primarily by positive developments in Asia and the US. We still find that the ECB is too downbeat.

The ECB still expects inflationary pressures to be low and Trichet reiterated that rates should remain appropriate. Their inflation projection for 2010 has been revised slightly down to 1.2% to 1.3% in 2010 and their mid-range expectation for 2011 was revised slightly higher to 1.5% from 1.4%. The upper end of their band for 2011 is now 2.1 % and thus flirting with the ECB target. From here they will not have to revise their inflation expectations much upward before they can defend to move away from the current record low refinancing rate.

The monetary analysis is not sending any signals that the ECB need to “lean against the wind” and hike rates. Although the ECB has emphasised that it can hike rates before the non-standard measures have been withdrawn, we do not see a hike before November 2010 at the earliest.

Market reaction

Market rates rose roughly 2-3bps as the press conference started. The reaction may, however, partly be explained by decent initial jobless claims data out of US (released 14.30 CET). The current pricing of EONIA futures still suggests that the ECB will not hike before August 2011, and we thus look for some upside potential for market rates in the short-end in the coming months.

Danske Bank
http://www.danskebank.com/danskeresearch

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