Central Banks Part 2: The ECB

Last meeting: December 2, 2010

Prior to last: November 4, 2010

Next meeting: January 13, 2011

Chairman: Jeane Claude Trichet

Currently, ECB's monetary stance is accommodative. Apart from leaving the main refinancing rate at 1%, the central bank delayed exit of non-standard measures and announced in December to keep providing unlimited liquidity to the market through Q1, 2011. The ECB extended the full allotment of the 3-month tender for a quarter. The 3-month LTRO (Long-term refinancing operation) will be conducted on January 26, February 23 and March 30 as fixed rate tender procedures with full allotment. In order to restore market confidence in the face of the sovereign crisis, ECB started buying government bonds in May under the Securities Market Program (SMP). As of December 24, the value of the accumulated purchases under the SMP was EUR 73.5bn with most of it spent during the first 3 weeks of the program. Although the ECB tried hard to convince the market at the launch of the program that it's not QE as all bond purchases would be sterilized, it turned out that only 60.78B euro was drained via 7-day term deposits, leaving almost 13B euro in the money market. We believe this is negative for the euro as the SMP is indeed no difference from QE in the US and the UK.

There have been talks that the ECB will step up liquidity provision and purchase peripheral debts. There's chance for the ECB to expand the scope of it purchases if the situation deteriorates rapidly as there is no limit on the duration or magnitude of the SMP. Should this materialize, the euro will get hammered as investors punish money-printing (like selloff in USD for most of the time in 2010).

ECB's decision in the coming year will be very challenging and opinions from policymakers will be more diverged. While peripheral economies welcome further easing, Germany should object the measures as tolerance of accommodative monetary policies for a prolonged period of time would mean higher inflation for Germany and this would damp the country's competitiveness.