ECB press conference: Status quo despite pessimistic assessment

As expected, yesterday’s press conference did not bring any surprising announcements, but it was the occasion to confirm that the ECB definitely does not feel that the crisis is resolved. Decisive action is needed from governments, first of all on banking union next week. Nevertheless, yesterday’s speech has tended to reinforce our expectations of seeing the ECB embark on new unorthodox measures soon in order to combat euro area fragmentation.

A rate cut has been contemplated
As widely expected, the Governing Council of the ECB decided to leave its monetary policy unchanged at yesterday’s meeting. Mario Draghi specified that a rate cut had been widely discussed, but the prevailing consensus was to leave interest rates at their current level. This press conference was also the occasion to confirm what the current main issues are.

Banking union at stake
The project for a banking union is a key element for resolving the crisis, but because of a broad divergence between members in the interpretation of the project, an agreement will be difficult to reach at next week’s, EU summit (13 and 14 December). Failure to do so next week could seriously dent the current ongoing favourable sentiment on financial markets regarding periphery countries. Mario Draghi used yesterday’s press conference to urge euro area leaders to take their responsibility.

Gloomy economic outlook
The second main concern is economic activity. Mario Draghi released the revised ECB staff projections. The 2013 GDP growth forecast has been severely revised down (from 0.5% to -0.3% for the middle point) towards our own forecast. This confirms the very gloomy outlook for the euro area economy. With an uncertain economic outlook, banks are naturally unwilling to lend, in particular to the periphery. As such, these economies are very likely to remain trapped in recession.

The battle to reduce fragmentation is not won yet
Mario Draghi confirmed that the fragmentation of the euro area remains a top concern for the Governing Council. The main consequence of the fragmentation is that the ECB’s efforts to relax monetary policy are not transmitted to the real economy, in particular in the periphery countries where they are most needed. If there is no relaxation in credit conditions soon, periphery countries are unlikely to begin their economic recovery again. Lasting recession will mean that public debt will again appear unsustainable in 2013 and could completely reverse the current favourable sentiment.

Encouraging bank lending: imagination is the limit
For this reason we expect the ECB to take new unorthodox measures swiftly to encourage – or even force – banks to fulfil their role as financial intermediaries. On this point it is worth noting that the ECB is much less constrained with intervening on private assets than it is on sovereign debt. A scheme similar toUK’s ‘funding for lending’ or accepting bank loans as collateral might be examples of measures to be taken. If the mandate of Single Supervisor Mechanism (SSM) is given to the ECB on 1 January, this will reinforce its coercive power on banks and thus help enforce decisions to encourage lending. This is therefore yet another reason why it is important for the SSM to be launched at the beginning of 2013.

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