ECB Meeting: Credit Easing

• ECB cut the refinancing rate by 25 bp to 1.0%. This is likely to be the end of this cutting cycle as the governing council seems reluctant to go below 1%.
• Trichet announced a package of non-standard measures. This includes the purchase of covered bonds in principle for possibly EUR 60bn and the introduction of a 12-month refinancing operation with full allotment at fixed rate.
• The EIB will be an eligible counterparty in ECB liquidity operations from July. This could generate additional lending programmes of EUR 40bn.
• The ECB see signs of stabilisation at very low levels and a gradual recovery in 2010. Trichet also noted that the downturn in Q1 was more severe than expected in March

The end of the cutting cycle

The refinancing rate was cut by 25 bp to 1.0% as expected by all forecasters. There have been plenty of signals from members of the governing council that they are reluctant to go below 1%, although it has never been fully ruled out. Trichet emphasised at the press conference that they had not decided that the current interest rate level is the lowest level possible.

The deposit rate was kept unchanged. The deposit rate has become more important after the ECB switched to full allotment at a fixed rate on the weekly auctions as it means overnight rates have been falling closer to the deposit rate rather than staying around the refinancing rate. The marginal lending rate was cut by 50 bp to 1.75%. As a result the rate corridor is symmetrical again. This has little practical importance, but looks nice.

We project that the policy rates will be kept unchanged for a long time and do not see a rate increase within 12 months. Nevertheless the ECB will be careful to avoid keeping the policy rates low for too long.

Non-standard measures

Trichet announced that the Governing Council has decided in principle that the Eurosystem (ECB and the European central banks) will purchase euro-denominated covered bonds issued in the euro area. However, this is not to be implemented immediately as the ECB will decide on technicalities at the next meeting on 4 June. Trichet noted that EUR 60bn looks like an appropriate level for what they are trying to achieve. The argument given for buying covered bonds is that this is one of the segments of private securities that have been most affected by the financial turmoil.

It is a disappointment that the ECB takes several months before first making the announcement, and then announces that they will wait another month before providing the details. It is still possible that the market situation will improve sufficiently without the help of the ECB so that they finally - after all the announcements - decide to leave the tools in the toolbox. However, we believe that now that we have got a number - EUR 60bn - the ECB will eventually embark on buying covered bonds. Trichet said that this is not quantitative easing - but in the Q&A session he did call it credit easing. As we see it, credit easing could be sterilised whereas quantitative easing cannot.

Trichet also announced as anticipated the introduction of a 12-month refinancing operation with full allotment at fixed rate plus a possible spread. This is positive, but the market impact is likely to be limited.

A surprise move was that the EIB will become an eligible counterparty in ECB liquidity operations from 8 July 2009 under the same conditions as any other counterparty. Trichet said that this could generate additional lending programmes of EUR 40bn. It is however not clear what kind of lending they will undertake.

The list of tangible assets used for collateral was also prolonged.

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

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