The European Central Bank (ECB)’s monetary policy meeting this coming Thursday will most likely disappoint after investors got their hopes up following ECB President Mario Draghi’s statement in July that the central bank was ready to do whatever was necessary to support the euro’s integrity.
After the ECB’s governing council meeting in early August, Draghi pledged that the central bank will resume its bond-buyingprogram but the promise did not calm markets for long, with investors now needing details and reassurance that this would end the crisis.
“September is a ginormous month for risk events in the eurozone and that could be enough for a shock during the month,” Peter Attard Montalto, Director and emerging market economist at Nomura, told Emerging Markets.
“Probably it will be enough of a shock to prompt [central banks in emerging markets] into cutting [interest rates].”
Financial markets face a “significant risk of disappointment” after the ECB monetary policy meeting on Thursday, Carl Weinberg, chief economist at High Frequency Economics, wrote in a market note on Wednesday.
“Overall, expectations that tomorrow’s ECB Council meeting will end with some communication that will resolve all concerns about the Euroland crises go far beyond anything that can be delivered,” Weinberg said.
“Tomorrow is fraught with risk, no matter what Dr. Draghi says.”
An economist told Emerging Markets last week that if the ECB does not act resolutely and quickly the eurozone faces deflationbut, as the meeting draws near, there is no consensus in the market on what to expect from the ECB governing council.
Some expect the bank to cut its main refinancing rate by another quarter of a percentage point to 0.5 percent – to “show willing” as Jennifer McKeown, senior European economist at Capital Economics, says – but admit that such a move would do little to improve the economic outlook.
Still, with the recession now spreading from the troubled eurozone periphery countries to the core and with new staff economic projections due, cutting the interest rate is the option favored by most analysts.
“Given the persistent downside risks, we think a rate cut is rather likely,” Mildred Hager, macro/fixed income analyst, eurozone, Erste Group, told Emerging Markets.
“Mr. Draghi might give some further details of the bond-buying plan but it is not clear if the whole program will be announced,” she added. “It could be that the ECB might need some time to make sure that everybody is, if not happy, at least not too opposed to the plan and also to ensure that it is in accordance with its mandate, so they might need more time to reach a compromise.”
“The program is conditioned by countries’ taking part in the ESM and the EFSF and neither Spain nor Italy has applied for EFSF or ESM help, also the ESM depends on what the German Constitutional Court will decide on September 12,” Hager said.
GERMAN CONSTITUTIONAL COURT
The German Constitution Court has to decide whether Germany’s participation in the European Stability Mechanism (ESM), the eurozone’s permanent rescue fund, is in line with the country’s constitution.
Around 12,000 claimants have asked the court to put an injunction on the treaty that created the ESM, arguing that it saps the German parliament’s right to decide on the country’s budget and it exposes Germany to big financial liabilities.
“If the court decides against an injunction, the German President can sign the ESM Treaty,” Michala Marcussen, an analyst with Societe Generale, said. “If the court – contrary to expectations – decides to place an injunction, that would place the ESM in limbo until a final ruling is rendered.”
The temporary rescue fund, the European Financial Stability Facility (EFSF), has around 150 billion euros of firepower left after the 100 billion euros bank bailout package for Spain; if the ESM kicks in, that would be boosted to around 400 billion euros, analysts at Societe Generale noted.
It is very likely that the ECB will disappoint markets this week again with its plans for peripheral government bond purchases, Capital Economics’ McKeown said.
“President Mario Draghi is likely to state that such purchases will be limited and that they will not begin until after the EFSF or ESM have bought bonds themselves,” she added.
Draghi, who pulled out of the Jackson Hole Economic Symposium last week invoking “a heavy workload,” sparked speculation that the central bank was working on an agreement on the measures to buy bonds.
“We would be very surprised if it failed to announce any plans, given the damage that this would do to market sentiment,” McKeown said.
“However, we suspect that those plans will be rather less concrete and more conditional than markets seem to hope.”
Last Wednesday, Draghi wrote in an article for German newspaper Die Zeit that “fulfilling our mandate sometimes requires us to go beyond standard monetary policy tools” and on Friday German newspaper Bild reported that the head of the Bundesbank, Jens Weidmann, had mulled resigning because he was opposed to new bond-buying plans by the ECB, the latest sign of political as well as economic troubles.
The clouds are gathering from other directions, as well.
“We’re only halfway through the crisis and we basically have Portugal needing PSI [private sector involvement by taking haircuts on government bonds, as was the case with Greece] to come, but that will probably happen in September to October, Spain will probably at some point lose market access or at least request a bailout, and all the [money] printing, and Italy as well... and Greece,” Attard Montalto said.
“We’re pretty bearish, not on September, but going into October, after all the risk events of September.”