Unsterilised ECB?

March 6, 2014

Foreign ministerial talks in Paris yesterday made little progress on Ukraine. Russia rejected Western demands that its forces in Crimea should return to their bases and its foreign minister refused to recognise his Ukrainian counterpart. Moscow continues to assert that the troops that have seized control of the Black Sea peninsula are not under its command. The West is pushing for international monitors to go in.

Today, at least some of the focus switches to Brussels where EU leaders will hold an emergency summit with a twin agenda of how to help the new government in Kiev and possible sanctions against Russia. On the latter, Europe has appeared more reticent than Washington not least because of its deep financial and energy ties, none more so than Germany and Britain.

The bloc yesterday offered Ukraine’s new government 11 billion euros in financial aid over the next two years, contingent on it reaching a deal with the IMF. It will also freeze the assets of ousted president Viktor Yanukovich and 17 others seen as culpable for violation of human rights – around 80 people were killed in the capital last month as they protested against Yanukovich’s rule. Kiev caused some market wobbles by saying it would look at restructuring its foreign currency debt.

NATO will cut back on cooperation with Russia and suspend planning for a joint mission linked to Syrian chemical weapons while increasing its engagement with Ukraine’s new leadership.

Since a bruising selloff on Monday as fears about a full military confrontation peaked, financial markets have calmed and are now probably more fixated on more regular fare:

Item 1 is today’s European Central Bank policy meeting after euro zone inflation held steady at 0.8 percent in February. That means inflation has now been in Mario Draghi’s “danger zone” below one percent for four months. The ECB insists it sees no risk of deflation but… Our poll of economists showed a growing minority saying QE will be needed. Most of the respondents said there would not be a rate cut this time but 26 of 78 said there would be one.

Printing money may be within the ECB’s mandate in extremis but it remains a very tough sell to many of its policymakers. So they will try everything else first. We think they will start today by ending operations to soak up money spent on Greek and other countries’ bonds at the height of the euro debt crisis.

The resultant release of around 175 billion euros ($242 billion) would roughly double the amount of excess liquidity in the euro zone financial system, should help bring down interbank lending rates and could also lower the euro’s exchange rate against the dollar.

The Bank of England will deliver its latest decision as well. No change will be forthcoming but there are some interesting hints coming from its rate setters after the abandonment of forward guidance pinned to a rapidly falling unemployment rate. Whether rates rise late this year or early next remains open to question but there is growing debate about the potential for wage increases to push up inflation.

Spanish and French bond auctions – the former for up to 5 billion euros of 3-, 5- and 10-year paper, the latter for up to 8 billion euros of long-term debt – will offer a test of market equanimity.

With EU elections hoving into view, and a new European Commission to be in place by the end of the year, jockeying for position is starting in earnest.

The centre-right European People’s Party grouping meets in Dublin and will vote to elect its candidate to head the EU’s executive at a two-day conference starting today which will be attended (after the Ukraine summit) by a mega cast-list – Jose Manuel Barroso, Herman Van Rompuy, Angela Merkel, Mariano Rajoy, Enda Kenny, Antonis Samaras, Jyrki Katainen, Pedro Passos Coelho and Viktor Orban.

Veteran Luxembourg politician Jean-Claude Juncker has won the backing of Germany’s ruling conservative party in the race to become European Commission president. As an arch federalist, his candidature will be anathema to Britain but it has opted out of the EPP grouping. Britain’s David Cameron must calculate whether his backing for any candidate for the top jobs would instantly scupper their chances.

Whichever political group emerges as the largest bloc in parliament following the May 22-25 elections is expected to have first claim on the presidency post, although the choice also has to be approved by EU leaders and history shows a compromise candidate has often come up to sneak it on the line.

The Socialists and Democrats group, currently leading in the polls, have selected Germany’s Martin Schulz, the president of the European Parliament, as their candidate. The Brits and others would be even more aghast if he took the helm and could block both him and Juncker.

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