Previewing The ECB's Interest Rate Decision

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From RanSquawk

PREVIEW: ECB’s rate-decision due to be released at 1245GMT followed by Draghi’s press-conference at 1330GMT

Super Mario is in the building…

Today marks the beginning of a new era for the ECB, with Mario Draghi taking over the helm from Jean-Claude Trichet as the President of the central bank. Unfortunately for Draghi, the changeover is to take place at a very critical juncture and at a time when market participants are demanding that the central bank takes more pro-active measures to stimulate the stagnating economy which stands on the brink of a double dip recession. However, such action may prove difficult for Draghi to push through the governing council since doing so only few months after Trichet announced that the central bank is to resume covered bond buying and 12-month LTROs risks undermining the central banks’ credibility. Another reason why a rate cut may prove futile is that the meeting coincides with the G-20 summit where leaders of the Eurozone are expected to endorse use of the leveraged EFSF fund as an investment opportunity for countries with a large budget surplus such as China and other BRICS. In turn this indicates that comments stemming from the summit may have a more profound impact on investors’ appetite for the EU related financial instruments and therefore determine whether the EUR/USD pair consolidates above the 1.4000 level.

As such, it looks more likely that the ECB will remain committed to further purchases of various EU bonds via the SMP program until lawmakers in Europe agree on finer details regarding the implementation of the recently proposed leveraged EFSF. This move will be particularly welcomed since the bond yield spread between the German 10-year and Italian 10-year BTP is trading back at record wide levels in spite of Berlusconi’s government introducing further austerity measures to meet the proposed deficit reduction levels. Nevertheless, given that the ECB does not pre-commit to future policy manoeuvre suggests that Draghi may leave the door open for a rate cut later in December should the economic conditions deteriorate further.

Elsewhere, policymakers will remain mindful of the recent controversy stirred by the Greek PM Papandreou after he called for a referendum on measures agreed by the EU leaders to tackle the Greek debt situation in a recent summit. The uncertainty caused by the announcement may prompt the ECB to refrain from further easing until the situation settles down. However, the Central Bank may need to continue with its stance of providing ample liquidity as well as continue buying Eurozone government bonds to micro-manage soaring bond-yields. If the latter is to be the case, Bunds will likely come under pressure and we may observe tightening of the Eurozone 10-year government bond yield spreads, while EUR may also receive support. Finally, ongoing volatility in Eurozone bank shares may guide the ECB to relax collateral rules and market participants will also watch keenly any comments pertaining to ECB’s USD-liquidity operations.