The European Central Bank meets tomorrow, rather than Thursday due to the national holiday in Germany. There is practically no chance that the ECB changes rates or its forward guidance. Nevertheless, there is much that officials have to discuss.
First, the September manufacturing PMI was the third consecutive monthly reading above the 50 boom/bust level. At 51.1, the September reading was a little lower than the 51.8 August print. Yet, there is no reason for the ECB to change its assessment that a gradual recovery appears at hand.
Second, disinflationary forces are tightening their grip. The preliminary September rate of 1.1% is nearly a four year low. The core rate stands at 1%. The ECB targets headline inflation at close to, but below 2%. The appreciation of the euro also warns of downside risk to imported prices, especially energy. Like the Federal Reserve, it needs to consider ensuring investors that it approaches its inflation target symmetrically. This is to say, that is will be just as concerned about inflation undershooting, as much as overshooting.
Some of the drop in inflation is due to the arguably exaggerated effects of the increase in administered prices, like VAT increases, that pushed up measured inflation and are now falling out of the calculations. This is a key factor that has seen the Spanish CPI fell to four year lows.
The decline in price pressures is taking place amid continued slow growth in money supply growth, one of the pillars of ECB monetary policy. In addition, private sector lending continues to contract.
Third, with banks continuing to pay down their LTRO borrowings, the excess liquidity is approaching the 200 bln euro threshold. Although ECB President Draghi has sought to de-emphasize the link between a certain level of excess liquidity and money market rates, especially EONIA, it requires continued monitoring. The quarter-end jump in EONIA, which practically doubled, and represents the second largest spike this year (after Q2), may illustrate the vulnerability of the market should excess liquidity continue to fall.
Fourth, it is too early to consider another LTRO. We think the risks increase as the outstanding LTROs enter their last year, which is toward the end of 2013 and early 2014. A two-year LTRO, would effective allow the extension of current borrowings for another year.
Fifth, the ECB appears to be slowly moving toward releasing some report of its discussions. Calling it minutes may be a stretch, but it makes sense to avail itself of a tool that can help facilitate its forward guidance and its communication more generally. It is one of the only major central banks that do release such a report. While a decision may not be likely until later this year, more discussion is likely.
Sixth, while US banks have returned to profitability, European banks have lost an estimated 80 bln euros over the past two years. One estimate suggested that as many as 10-times more banks have closed in the US than in Europe. TARP, which was initially to buy toxic assets from US banks morphed into a forced recapitalization scheme. Europe is moving toward a banking union, but at unbearably slow pace. Next year the ECB is to take on the single supervisory function.
In order to do so properly, it has proposed a three-prong process. First, it wants to evaluate the business models of the banks to discover where the risks are to be found. Second, it was to assess the balance sheets and make sure the assets are properly classified and valued. Third, it want to make the makes undergo new stress tests.
However, to the findings triggering a new financial crisis, it needs a backstop, the single resolution. mechanism. Estimates for how much capital the European banks needs are all over the board. One investment bank was quoted with an estimate near 16 bln euros, while others estimate 45 bln euros for the top German banks alone.
The EU has suggested funding the single resolution mechanism with 55 bln euros, without apparently knowing the need. The risk is that the mechanism is under-funded as the creditor countries, and those with relatively stronger banks, and banks that can raise the funds in the capital markets, do not want to subsidize those with weaker banks. Another issue is whether this resolution mechanism can borrow from the ESM.
First, the September manufacturing PMI was the third consecutive monthly reading above the 50 boom/bust level. At 51.1, the September reading was a little lower than the 51.8 August print. Yet, there is no reason for the ECB to change its assessment that a gradual recovery appears at hand.
Second, disinflationary forces are tightening their grip. The preliminary September rate of 1.1% is nearly a four year low. The core rate stands at 1%. The ECB targets headline inflation at close to, but below 2%. The appreciation of the euro also warns of downside risk to imported prices, especially energy. Like the Federal Reserve, it needs to consider ensuring investors that it approaches its inflation target symmetrically. This is to say, that is will be just as concerned about inflation undershooting, as much as overshooting.
Some of the drop in inflation is due to the arguably exaggerated effects of the increase in administered prices, like VAT increases, that pushed up measured inflation and are now falling out of the calculations. This is a key factor that has seen the Spanish CPI fell to four year lows.
The decline in price pressures is taking place amid continued slow growth in money supply growth, one of the pillars of ECB monetary policy. In addition, private sector lending continues to contract.
Third, with banks continuing to pay down their LTRO borrowings, the excess liquidity is approaching the 200 bln euro threshold. Although ECB President Draghi has sought to de-emphasize the link between a certain level of excess liquidity and money market rates, especially EONIA, it requires continued monitoring. The quarter-end jump in EONIA, which practically doubled, and represents the second largest spike this year (after Q2), may illustrate the vulnerability of the market should excess liquidity continue to fall.
Fourth, it is too early to consider another LTRO. We think the risks increase as the outstanding LTROs enter their last year, which is toward the end of 2013 and early 2014. A two-year LTRO, would effective allow the extension of current borrowings for another year.
Fifth, the ECB appears to be slowly moving toward releasing some report of its discussions. Calling it minutes may be a stretch, but it makes sense to avail itself of a tool that can help facilitate its forward guidance and its communication more generally. It is one of the only major central banks that do release such a report. While a decision may not be likely until later this year, more discussion is likely.
Sixth, while US banks have returned to profitability, European banks have lost an estimated 80 bln euros over the past two years. One estimate suggested that as many as 10-times more banks have closed in the US than in Europe. TARP, which was initially to buy toxic assets from US banks morphed into a forced recapitalization scheme. Europe is moving toward a banking union, but at unbearably slow pace. Next year the ECB is to take on the single supervisory function.
In order to do so properly, it has proposed a three-prong process. First, it wants to evaluate the business models of the banks to discover where the risks are to be found. Second, it was to assess the balance sheets and make sure the assets are properly classified and valued. Third, it want to make the makes undergo new stress tests.
However, to the findings triggering a new financial crisis, it needs a backstop, the single resolution. mechanism. Estimates for how much capital the European banks needs are all over the board. One investment bank was quoted with an estimate near 16 bln euros, while others estimate 45 bln euros for the top German banks alone.
The EU has suggested funding the single resolution mechanism with 55 bln euros, without apparently knowing the need. The risk is that the mechanism is under-funded as the creditor countries, and those with relatively stronger banks, and banks that can raise the funds in the capital markets, do not want to subsidize those with weaker banks. Another issue is whether this resolution mechanism can borrow from the ESM.
ECB: Much to Discuss, but Little Action
Reviewed by Marc Chandler
on
October 01, 2013
Rating:
Reviewed by Marc Chandler
on
October 01, 2013
Rating:
