ECB Preview: It Could be a Non-Event

• We are confident that the ECB will leave the refinancing rate unchanged at 1.0%. We expect the ECB to keep rates unchanged for a prolonged period before they begin to hike.
• The focus will therefore be on the press conference. We will look for signs that the ECB rhetoric is becoming more positive, but we don't expect much.
• We do not anticipate the ECB to announce additional measures or top up on already announced measures. All in all, this might be a relatively dull ECB meeting - for a change.

Policy rates likely to be kept unchanged for a long time

We are reasonably sure that the ECB will keep the refinancing rate unchanged at 1% at its meeting on Thursday. The flash inflation for June released today showed that inflation is now in negative territory at -0.1%. Inflation is likely to fall further in July and then return to positive territory in October. However, the ECB is not very concerned about the prospect of negative inflation this summer. The ECB's governing council has its eyes firmly focused on the medium term. In the medium term, deflation is not a great concern given that both core inflation and inflation expectations remain stable and there is an increasing number of signs of an economic rebound.

The monetary data released today also signals weakness. M3 annual growth declined more than expected to 3.7% in May from 4.9% in April, and growth in loans to the private sector continues to decline and now stands at just 1.9%, down from 2.3%. We expect a further decline in M3 in June, but could soon start to see a stabilization in money and lending growth rates as the economy improves and the massive stimulus undertaken by the ECB works its way through the system.

The low level of money and credit growth leaves plenty of room for the ECB to cut rates further towards zero. There have however been plenty of signals from members of the governing council that they are reluctant to bring the refinancing rate below 1%, and with the record breaking auction last week (see below) the ECB will argue that it is doing enough to revitalize the economy. We do not think that the ECB will lower rates further unless the economic prospects deteriorate again and they start to see a real risk of deflation.

The policy rates are projected to be kept unchanged for a long time. We do not see a rate hike within 12 months, but possibly shortly after (in Q3 2010). Nevertheless the ECB will be careful to avoid keeping the policy rates low for too long, and when the economy starts to pick up we should watch out for signals of an early surprise move from the ECB.

Press conference

We will look for signs that the ECB rhetoric is becoming more positive, but we don't expect much. Confidence indicators have improved further during the last month, but although ZEW is sending very positive signals, the PMI disappointed with a tiny improvement. European hard data is only showing signs of a stabilisation at best. Asian hard data have continued to improve, but it would surprise us if that were enough for the ECB to become more lighthearted.

We do not anticipate that the ECB will announce additional measures or top up on already announced measures. It is possible that we will get more details on the purchase of covered bonds or the forthcoming 12 months auction in September, but probably not.

The ECB had its first liquidity-providing longer-term refinancing operations with a maturity of 12 months last week and flooded the market with liquidity. The auction was fixed rate (equal to the main refinancing rate) with full allotment as announced in May. The auction was possibly a one-off opportunity to secure very cheap liquidity with a relatively long maturity, and banks thus took up EUR442.2bn – far more than at any other ECB auction.

In the 12 months refinancing operations with full allotment in September and December, the fixed rate may include a spread in addition to the rate in the main refinancing operations, depending on the circumstances at the time. It may thus not be as good an offer as last week's auction, which did not include a spread. It is most likely that the ECB will wait until the Governing Council meeting in September before it gives further information on whether a spread will be added and the size of it.

Recent comments from ECB Governing Council members

Lorenzo Bini Smaghi (Executive Board), June 25

“This crisis demonstrates that if a central bank is concentrated on near term results, on the pursuit of growth at all costs, this leads it to conduct policies that increase instability.”

Juergen Stark (Executive board), June 25

“It is obvious that we cannot maintain the current degree of enhanced credit support indefinitely. Macroeconomic conditions will improve, and when they do, we will make sure that the measures adopted are unwound swiftly and the liquidity provided is absorbed, so as to maintain price stability over the medium term.”

Lorenzo Bini Smaghi (Executive Board), June 24

"This enormous expansion of monetary liquidity created to tackle this crisis must clearly be eliminated quickly to avoid the same phenomena we have seen before and (avoid) fuelling a speculative bubble."

Ewald Nowotny (Austria), June 22

"If the economy is developing in the way that we expect, I do not see a perspective for [rate changes] this year and we will need to look again next year."

Jose Manuel Gonzales-Paramo (Executive board), June 19

"Exit strategies can only be planned when you have clear signs to exit, and it's very early for this, but it's never too early, on the other hand, to think about exit strategies. It's too early to start to plan."

Axel Weber (Germany), June 16

"There is no need for further policy measures at the moment. ... The stabilization of the situation and the already-mentioned uncertainty of forecasts about economic developments in the coming quarters require something else: looking forward already to the time past the crisis."

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

Disclaimer

This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff, may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. Danske Markets´ research analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for private customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S, which is regulated by FSA for the conduct of designated investment business in the UK and is a member of the London Stock Exchange. Copyright (©) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission.