ECB’s interest rate decision due at 1245GMT (0645CST) followed by Draghi’s press-conference at 1330GMT (0730CST)
• Likely to cut interest rates by another 25bps, an outside chance of 50bps cut
• May announce a provision of bank loans lasting up to two or three years
• No pre-commitments to buy EU based bonds or act as a lender of last resort
Global equity markets and in particular the financial sector has been under severe stress recently, which in turn meant that the ECB had to cut borrowing rates, provide USD-funding and re-introduce long-term money operations, as well as announce another covered bond buying program. However market participants continue to criticize the central bank for its lack of “bazooka” resembling action, which in the eyes of many will be a surrender to unlimited purchase of various government bonds.
Given pressure on the central bank continues to build, today the ECB is widely expected to cut the benchmark borrowing rate by another 25bps, with an outside chance that members will push for a 50bps cut. Apart from cutting the interest rate, press reports indicated that some members of the ECB governing council have been debating on providing bank loans lasting up to two or three years. An alternative solution would be to broaden the range of assets banks can use as collateral to obtain funds from the central bank. Highlighting deteriorating condition in money markets in Europe is the last data from the Bank of Italy, which showed that funding from the ECB to Italian banks rose sharply to EUR 153.2bln in November from EUR 111.3bln in October. In addition to that, the head of UniCredit has urged the ECB to increase access to ECB borrowing for Italian banks, while the Bank of Italy launched twice-daily overnight liquidity auctions to boost access to capital. Still, despite the persistent widening in the 3-month Euribor-OIS spread and the TED spread, the 3-month EUR/USD cross-currency basis swap has edge back towards -100bps mark, that’s after trading -152bps only few weeks ago (Note: post Lehman Brothers collapse in October 2008 saw 3-month EUR/USD cross-currency basis swap trade at -215bps).
The press conference will likely be dominated by questions surrounding the controversial Securities Markets Program (SMP) and prospect of lending money to the IMF to by-pass various EU treaties. Those looking for a fully fledged QE announcement will likely be disappointed yet again and Draghi is expected to reiterate that the SMP is a temporary solution and that the central bank will not be acting as a lender of last resort. In addition to that, purchases of bonds will be passed over to the EFSF, once that is fully operational and that no pro-commitments will ever be made on maximum size of weekly purchases. As a result, market participants should pay close attention to price action in the short-end, which will likely be susceptible to unusually high volatility, which in turn will drive demand for riskier assets. Despite concerns over the future safe-haven status of German Bund, lack of alternative (apart from UK Gilts), implies that at least in the near-term markets will continue to view the benchmark as the ultimate risk-less asset.
Staff projections to be revised
Reflecting the economic slowdown in the Eurozone as confirmed by the PMI readings, the ECB is expected to significantly mark down growth projections. At the same time, inflation projections are unlikely to be subject to considerable alteration.