The ECB announces its monetary policy decision on Thursday and is widely expected to keep rates unchanged at 1.25 per cent.
What’s much less clear is whether President Trichet will use the phrase “strong vigilance”.
That’s important because of the traffic light system the ECB uses to signal impending interest rate rises. When the words “strong vigilance” are muttered, a hike is never far away.
At last month’s meeting, Trichet left the door ajar for further increases, potentially as early as June, given the use of the phrase “monitor very closely”, which has been historically consistent with a rate hike potentially two months away, says RBS.
However, given the deteriorating situation in Greece and Portugal, the ECB’s governing council might decide to hold fire and wait until July, reckon RBS economists Silvio Peruzzo and Jan Dubsky:
The April statement emphasised that interest rates remain low and the monetary policy stance remains accommodative, and we continue to believe there is a bias within the Council for normalising interest rates from their emergency setting given the extent of the euro-area recovery in aggregate and inflation backdrop. If we are correct in asserting that the Council chose its words carefully in April to leave a rate hike in June clearly in play then, given the periphery has taken another turn for the worse, there is likely to be a debate within the Council as to whether this influences its thinking and supports waiting until July.
However, we expect the view to emerge that, having told the market there is a separation principle that allows the ECB to normalise while supporting the periphery, the ECB can continue normalising while still providing liquidity. Therefore, we think it is likely the separation principle will win the day. Furthermore, we believe the ECB will only stop its normalisation process when and if the deterioration in the economic and financial conditions in the periphery has euro-area-wide implications.
But it’s going to be a close call says Michael Saunders of Citigroup:
The ECB is likely to leave rates unchanged at 1.25% in May. But, recent comments by ECB officials suggest that they will hike interest rates further in order to prevent second-round effects from commodity price gains. It is a close call if the next move will be in June or July. We still have a preference for July, but it may well be that the ECB will use the “strong vigilance” phrase in May in order to signal that the next rate hike will take place in June.
Indeed, recent economic data suggests the ECB will be forced to revise its inflation forecasts higher at the June meeting. RBS reckons the Governing Council is looking at a 2011 inflation forecast of around 2.7 per cent (vs 2.3 per cent in March).
But interest rates won’t be the only topic of conversation at the ECB this week. Non-standard measures will also be discussed.
According to RBS:
The discussion regarding addicted banks/persistent bidders is likely to remain unresolved and we expect no announcement of a solution at this month’s meeting. The crystallisation via last month’s rate hike of the separation principle between the standard and non-standard measures, Pdt Trichet’s recognition that the persistent bidder situation remains a complex problem and comments since the last meeting suggesting it is: a) too early to say when the non-standard measures will be withdrawn; and b) they will be withdrawn at an appropriate pace imply an increasing chance of a delay in the return of 3m LTROs to variable rate tenders until Q4 2011 at the earliest.
Neither does Saunders expect a decision on the introduction of a special term funding facility for those persistent bidders:
After “deciding not to make a decision” on the introduction of a special term funding facility for the “persistent bidders” in April, we expect again no decision on the issue in May. As we have discussed before, such an introduction of a special funding facility for the weak banks, with likely extra requirements on collateral and a higher interest rate, would create additional pressure on those banks, which are mainly based in the periphery countries. Such an increase in banks’ funding cost would create an undesirable additional tightening in overall financing conditions in the periphery countries.
But make no mistake that it’s coming, as is the demise on the Securities Markets Programme:
Following the low use of the program in recent weeks and backed from comments of previous advocates of the SMP (like the Cyprus Governor Athanasios Orphanides), the need for the program has diminished, and the ECB is likely to end this program in the remainder of the year. However, the timing is uncertain. Most likely looks to us an ECB decision to end the SMP after the June European Council meeting in which the EU Heads of State and Government probably will approve changes to the EFSF.
RIP.
Related links:
ECB bond-buying, 2010-2011: in memoriam – FT Alphaville
ECB looks set for tough new style – FT
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