ECB eclipsed by BOJ

April 4, 2013

The European Central Bank takes centre stage. While others in the euro zone are saying the way Cyprus was bailed out – with bank bondholders and big depositors hit – could be repeated, the ECB insists it was a one-off.

Fearful of any signs of contagion it will continue to talk that talk and there’s no sign of it having to do more so far, with no bank run even in Cyprus let alone further afield. But the last two weeks has reignited debate about what the ECB might have to do in extremis. It’s no nearer deploying its bond-buying programme but it could flood the currency area’s financial system with long-term liquidity again if called upon.

Interest rates are expected to be held at a record low 0.75 percent. Hints of policy easing further out are not out of the question. As ever, Mario Draghi’s hour long press conference will be minutely parsed but there will be nothing to match the Bank of Japan which earlier announced a stunning revamp of its policymaking rules – setting a balance sheet target which will involve printing money faster and pledging to double its government bond holdings over two years.

That could revive the debate about competitive currency devaluations with the yen inevitably set to fall while the ECB has little in its arsenal to respond. A stronger euro is the last thing the currency bloc’s struggling economy needs.

The Bank of England could respond and is also meeting today but it is not likely to turn on the money printing presses again just yet although Governor Mervyn King and two of his colleagues have already voted to do so for two months running (the other six disagreed). If it is to come, it is more likely in May when the Bank publishes it quarterly inflation report.

Also today, Dutch Finance Minister Jeroen Dijsselbloem holds his monthly debate in parliament. The new head of the Eurogroup put the cat among the pigeons by boldly telling us that future bank bailouts would look to hit bondholders, shareholders and even rich depositors a la Cyprus. Markets took fright and he partially backtracked. But the notion was then given fresh impetus by the European Commission and others.

Germany and its northern European allies are clearly desperate to keep their taxpayers off the hook for any future rescues but how this affects investor sentiment towards the euro zone and plans for its banking union remains to be seen. It’s a very live, utterly crucial part of the euro zone’s future. Again, Draghi may have something to say while the French and German finance ministers are out and about together in Strasbourg.

There is little sign of the euro zone economy outside Germany picking up. Following some gloomy manufacturing PMI surveys on Tuesday, we get the service sector equivalents for single currency members and Britain. They are unlikely to change the big picture. France is a particular worry since if it trails badly in Germany’s economic wake that also has profound political implications for what was once the twin motor of the European project.

Paris holds a bond auction but is still borrowing at rock-bottom yields. Spain also returns to the market with a three- and five-year bond issue.

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