To print or not to print

March 7, 2013

It’s ECB day and it could be a big one, not because a shift in policy is expected but because journalists will get an hour to quiz Mario Draghi on the Italy conundrum after the central bank leaves monetary policy on hold.

To explain: The story of the last five months has been the bond-buying safety net cast by the European Central Bank which took the sting out of the currency bloc’s debt crisis. But now it has an Achilles’ heel. The ECB has stated it will only buy the bonds of a country on certain policy conditions encompassing economic reform and austerity. An unwilling or unstable Italian government may be unable to meet those conditions so in theory the ECB should stand back. But what if the euro zone’s third biggest economy comes under serious market attack? Without ECB support the whole bloc would be thrown back into crisis and yet if it does intervene, some ECB policymakers and German lawmakers will throw their hands up in horror, potentially calling the whole programme in to question.

In Italy, outgoing technocrat premier Monti is due to meet centre-left leader Bersani, the man still harbouring hopes of forming some sort of government. Whether he succeeds or not it seems unlikely that any administration can ignore the dramatic anti-austerity vote delivered by the Italian people.

Draghi will doubtless stonewall on all this but there’s plenty else to chew on. New economic forecasts by ECB staff will presumably look grim and increase speculation about an interest rate cut. But the ECB keeps saying that its focus is getting already record low rates transmitted to all parts of the euro zone and those high debt corners where banks, businesses and people cannot access anything like those low rates. That begs the question what difference would a quarter-point rate cut really make, which leads on to another: what else can the ECB do?

On the nerdy front, a further loosening of collateral rules, which banks can offer up in return for ECB liquidity, is in the pipeline. More profoundly if things continue to get worse, something similar to last year’s deluging of banks with more than one trillion euros of ultra-cheap three-year money could come onto the table (though not yet).

The Bank of England will also deliver its monthly policy decision. Policy stasis will probably be the order of the day again but it’s a much closer call after Governor Mervyn King was outvoted in calling for more money printing last month. Our poll puts a 40 percent chance on it happening this time. When King has been outvoted in the past, he has more often than not got his way some time later.

Prime Minister David Cameron will use a speech to insist the government’s debt-cutting Plan A will not be tampered with despite a return to recession and the loss of Britain’s AAA rating. But the FT says the government may use its budget in a fortnight to spell out a revised remit for the Bank of England, which could formalize the case for leaving inflation higher for longer. Heir apparent Mark Carney told UK lawmakers last month that the bar to changing the rules was high but he’s also known as someone prepared to challenge the status quo. Cracks in the coalition government are opening again. Business Secretary Vince Cable says the time may be ripe to increase borrowing to pump prime the economy.

On the primary debt market, there are still few problems but today provides another test. Spain will sell up to five billion euros of two-, five, and 10-year debt. France, still borrowing at rock bottom rates despite an economy that appears to be worsening by the week, will auction up to 7.5 billion euros of 2022 and 2027 bonds. Given the ECB’s backstop – our polls show it is still expected to intervene on Spain’s behalf this year – it is questionable whether Italy poses a contagion risk as it would have done last year. Certainly Madrid is attracting investors for its debt.

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