Germany remains vehemently opposed to any euro-wide deposit guarantee scheme as the head of the association of savings banks believes it: "would lead to a spreading of risks to the detriment of German financial institutions" and that this would "increase the burden for national protection schemes, which is not in the interest of German banking clients". Not exactly encouraging and along with the fact that Goldman notes that Germany's 'growth plan' (which includes increasing EIB capital and redirecting existing funds to the periphery) with which it will attempt to bolster its opposition to soaking up more peripheral risk, contains 'nothing really new in it'. For this reason Goldman is far less sanguine heading into the ECB meetings as they hope for the best and prepare for the worst. They expect Draghi's forward-looking statements on being ready to act, conditional on events in the periphery, will be the most important headlines but expect him to remain stoic in his position on governments contributing to the solution. Goldman's view remains that, at least for the time being, the ECB has to play a leading role in stabilising the system (though SMP remains marginalized given its potential to sit outside of the ECB mandate) given that it can operate more quickly and more effectively, given the many political constraints governments face. A genuine long-term solution, however, falls once again in the domain of governments.
German government prepares "growth package"; nothing really new in it. According to news reports, the German government has been working on a list of measures to support growth in the Euro area. The list includes measures such as increasing the European Investment Bank's capital by around €10 billion and redirecting existing money in EU funds towards the periphery. There seems to be nothing really new on the list and there is no indication that the German government would now be in favour of any large public spending programme. The German government will use this list for its forthcoming discussion with the opposition on the fiscal compact, scheduled for June 13. The government needs the support of the opposition in order to get the fiscal compact through parliament. The opposition has demanded that, in exchange for its support, the government should come up with specific measures to support growth in the periphery.
German banks critical on proposed support measures for peripheral banks. The head of the association of savings banks, Fahrenschon, wrote in an op-ed in FTD that a Euro area wide deposit guarantee “would lead to a spreading of risks to the detriment of German financial institutions” and that this would “increase the burden for national protection schemes, which is not in the interest of German banking clients”. The association of private banks, BdB, at the same time has rejected in a written statement direct financial help for peripheral banks from the EFSF. Such help would be conditional on a restructuring of the banking sector and only national governments would ultimately be in a position to ensure that such conditions were met.
Portuguese government to inject €6.63 billion into banks. Portuguese Finance Minister Gaspar said yesterday that Portugal will use money from its current EU/IMF programme, earmarked for supporting banks, to bolster the capital position of its three biggest banks.
Focus: ECB preview: Hoping for the best, preparing for the worst
Bottom line: We expect the ECB to keep rates on hold this Wednesday and also expect no announcement of further non-standard measures. Further ECB actions are to a great extent conditional on events in the periphery, and on the implication these events will have for the wider Euro area and the financial system. ECB President Draghi is likely to use the press conference as an opportunity to signal that the ECB will in principle stand ready to support the system if needed. However, Draghi is also likely to remind governments forcefully that they must contribute to the solution and that the ECB can only accommodate what in the end is a political process.
Growth outlook (a lot) more uncertain
Growth at the beginning of the year was somewhat stronger than we had expected and the Euro area economy 'only' managed to stagnate, after a small decline in economic activity at the end of last year. Stronger than expected numbers out of Germany and Spain - although the Spanish economy still contracted by 0.3%qoq - were the main reason for this, more than offsetting a negative surprise in Italy.
However, the latest monthly indictors coming out of the Euro area suggest that the economy is losing momentum again and our Current Activity Indicator, which uses information up to April, is consistent with a small decline in GDP. The May business surveys imply this downward trajectory continued last month (for more on the outlook see our latest European Views).
In the May introductory statement, the ECB’s Governing Council's view was that the “latest survey indicators for the euro area highlight prevailing uncertainty. Looking ahead, economic activity is expected to recover gradually over the course of the year”. This outlook, according to the Governing Council, “continues to be subject to downside risks”. We think the June statement will now acknowledge that an easing in economic activity during the summer is likely, but will at the same time still expect an improvement by the end of the year. Thus, we expect “gradual recovery” to remain part of the Governing Council’s main scenario.
We also expect the deterioration seen in the data since March to be reflected in a downward revision of the June staff projections. While a revision to our more pessimistic outlook for Euro area growth of -0.5% for this year seems unlikely, we could see the staff now forecasting – after -0.1% for 2012 in March – a more pronounced weakness in the coming two quarters, leading to an annual growth forecast of around -0.3%.
A downward revision of the 2012 annual figure to around -0.3% would imply that the ECB’s staff expect the current weakness to be temporary, followed by a stabilisation by the end of the year and a return to positive growth in 2013. Next year’s growth forecast of +1.1%, in this scenario, is unlikely to be changed much (GS: +0.4%).
A more significant change in the staff projections would signal a more fundamental reassessment of the current situation, and would also, everything else equal, make further policy easing - including a reduction in rates - more likely.
As far as the inflation outlook is concerned, the May statement saw inflation staying above 2% in 2012, but “over the policy-relevant horizon, we expect price stability to remain in line with price stability" and “risks to the outlook for HICP inflation rates in the coming years are still seen to be broadly balanced”. This risk assessment is unlikely to change, although we could see the Governing Council signaling a small reduction in the underlying inflationary pressures by deleting “still” from the sentence in the statement describing the risk assessment.
The somewhat more benign outlook for inflation should also be reflected in a moderate downward revision of this year's forecast of 2.4% on the back of weaker growth and lower energy prices (for example, back in March the staff assumed a price for Brent crude oil of US$115 for this year) and a broadly unchanged figure for next year (+1.6%; GS: 2.4% in 2012 and 1.9% in 2013). Again, a more substantial downward revision of inflation would signal a fundamental reassessment of the outlook for the Euro area.
ECB to remain on hold in our base case scenario...
ECB actions remain to a great extent conditional on developments in the periphery at this point, and on the implications these events will have for the wider Euro area and the financial system. Ultimately, it is the implications for the Euro area as a whole that the ECB cares about. Our base scenario foresees a 'muddling-through' in Greece, with the newly elected government unlikely to choose an exit from the Euro or implement the EU/IMF programme unconditionally. Meanwhile, it is likely that Spain will eventually have to ask for external financial help to support its banking system. All this is likely to be accompanied by slow progress – mostly consisting of announcements – on deeper policy integration and the building of higher financial firewalls.
We expect the ECB to keep rates on hold in this 'muddling-through' scenario. That said, the ECB will stand ready to provide liquidity to banks, as it has in the past, and we expect the ECB to extend the deadline up to which it will operate its current full-allotment regime in its refinancing operations significantly, potentially until the end of the year. Emergency Liquidity Assistance (ELA) should be the main tool through which additional liquidity needs will be met (see our European Daily Comment from May 31 for more details).
President Draghi is likely to be asked during the press conference about the preparations the ECB has made in the event Greece leaves the Euro. While Draghi will probably simply say that the ECB expects Greece to remain part of the Euro area, he may want to use this opportunity to stress the ECB’s willingness to support banks in the event of a liquidity shortfall.
...but would come out in force if needed
We could see the ECB engaging in a wide range of non-standard measures in order to safeguard the system should events turn out to be more disruptive. Liquidity measures such as additional LTROs, possibly beyond 3 years, and a further widening of the collateral framework would be part of the ECB’s response to a sharp rise in tensions on the back of, for example, a disorderly Greek exit from the Euro.
Outright purchases of financial assets are also conceivable in such a scenario. The hurdle for reactivating the SMP seems high at this point and several Governing Council members have been sceptical about whether the SMP would fall within the ECB’s mandate and about the overall effectiveness of the programme. Moreover, with the EFSF now in a position to buy government debt in the secondary market, the ECB is unlikely to be eager to use its balance sheet to stabilise peripheral yields.
The ECB could therefore consider outright purchases in other market segments, including bank debt. But depending on the sharpness of such moves, the SMP may very well be reactivated on short notice.
Political coverage necessary
Implicit or explicit approval by Euro area governments would be required for the ECB to engage in a new round of additional support measures in a disruptive scenario. Whether this support for the ECB would take the form of a common declaration by governments or individual statements is difficult to say. But whatever shape or form such political backing took, it would clearly increase the ECB’s effectiveness in dealing with the situation. Our view remains that, at least for the time being, the ECB has to play a leading role in stabilising the system given that it can operate more quickly and more effectively, given the many political constraints governments face. A genuine long-term solution, however, falls once again in the domain of governments.