ECB: talk but no action

July 3, 2014

EThe European Central Bank holds its monthly policy meeting and after launching a range of new measures in June it’s a racing certainty that nothing will happen this time. However, ECB President Mario Draghi has plenty of scope to move markets and minds in his news conference.

We are still waiting for details of the ECB’s new long-term lending programme which is supposed to be contingent on banks lending the money on to companies and households. Last time they got a splurge of cheap money, the banks largely invested in government bonds and other financial market assets. With euro zone yields now at record lows, the ECB would not like to see a repeat.

Draghi will certainly be asked to clarify what looked like a new attempt at forward guidance. Last month, the ECB offered up new four-year loans to banks, and extended its offer of unlimited liquidity to the end of 2016.

Draghi subsequently said that was a signal that rates could stay at a record low 0.15 percent for longer than previously foreseen. Did he mean until the end of 2016, or even 2018 when the new long-term loans expire?

If so, it would be a brave investor that would take it at face value. Central bank forward guidance has been fraught with difficulty. Item 1 is the Bank of England which only last year was talking about rates staying at record lows into 2016. Now, the consensus is that a first upward move could come this year with house prices going through the roof (excuse the pun).

Draghi continues to say that printing money would be an option if deflation really looked like taking hold, something the ECB still does not expect. Others in Frankfurt are much more doubtful so the mood music on that will be crucial.

If the ECB was forced to adopt QE, despite the philosophical difficulties, it would be doing so as others – most notably the Federal Reserve – are about to stop.

One deciding factor will be what impact the new long-term loans to banks have. With stress tests due late in the year and banks being told to clean up their balance sheets, a new wave of lending is unlikely.

The ECB has talked about reviving securitization – whereby loans can be bundled up and sold on – in order to facilitate its attempts to get lending going. But details are thin on the ground despite Draghi’s assertion last month that preparatory work was intensifying.

Sweden’s Riksbank also has a rates meeting and is expected to cut by a quarter point to 0.5 percent as it struggles to reach its two percent inflation target. It will also push the first projected rate hike further into the future. In April, the Riksbank foresaw no rate hike until the first half of 2015.

Prior to the ECB’s decision, service sector PMI surveys for euro zone countries will give the latest snapshot of a still sluggish economic recovery. China’s PMI showed its service sector grew at the fastest pace in 15 months in June.

Spain will auction up to 4.5 billion euros of five- and 30-year bonds after Portugal – despite one of its banks teetering – successfully placed $4.5 billion in dollar-denominated 10-year bonds at yields it could only dream of at the height of the euro debt crisis.

Ireland also took advantage of low borrowing costs, cutting its funding requirement for 2016 by 2 billion euros through a bond swap and buyback.

Overall for the markets, the monthly U.S. jobs report (a day early due to the U.S. Independence Day holiday) will hold sway.

The show quickly moves on to Berlin where Chancellor Angela Merkel speaks at a business conference run by her conservative party. Finance Minister Wolfgang Schaeuble and Irish premier Enda Kenny will also feature during the day and, once the ECB dust settles, Draghi, Bundesbank chief Jens Weidmann and Schaeuble are all on an evening panel.

Last night, the foreign ministers of Russia and Ukraine agreed to hold three-way talks involving pro-Moscow rebels by Saturday to pave the way for a new ceasefire, despite continued fighting.

History shows it’s hard to judge from rhetoric alone but Russian Foreign Minister Lavrov’s aim for a “stable, long-term truce” could be seen as a positive. Merkel had warned Moscow shortly before the talks that economic sanctions remained an option unless it backed peace efforts.

Iraqi Prime Minister Nuri al-Maliki said on Wednesday he hoped parliament could form a new government in its next session after the first collapsed in discord. Mounting pressure from the United States, Iran, the United Nations and Iraq’s Shi’ite clerics have done little to end the paralysing divisions between Iraq’s main sectarian blocs.

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