Yesterday’s European Central Bank press conference came as a severe disappointment to many in the financial markets who had expected a major policy announcement in response to the increasingly severe strains in the euro zone bond market of late and ongoing sovereign debt issues in the EMU.
The ECB did decide to postpone further steps in its move away from exceptional liquidity support measures to the banking system and also hinted that bond buying through its Security Market Program might be stepped up. This was far less than had been anticipated in recent days. It may take a little time for markets to assess whether the ECB response could take the form of deeds rather than words – reports suggest aggressive ECB bond-buying took place even as Mr. Trichet was speaking.
However, the risk must be that markets eventually interpret the failure of the ECB to deliver ‘shock and awe’ today as indicating that it is either unable or unwilling to take measures to reverse current bond market pressures. Unfortunately, in extremely nervous market conditions such shortcomings may tend to prompt renewed pressures and even more fundamental questions about the workings of EMU in the weeks ahead expectations today.
There are quite a number of possible explanations for the ECB’s failure to match market expectations
First of all it might be argued that traders had wrongly interpreted remarks made by Mr. Trichet earlier in the week. His warning that the commitment of policymakers to the euro zone shouldn’t be underestimated was taken as hinting at imminent action – a judgment that may have been encouraged by some inside or familiar with the workings of the ECB. Although, this is a relatively minor matter, this week has been a very bad one for the communications strategy of the ECB.
Projections Provide Some Room For Maneuver
On a more significant level, the lack of a decisive new initiative by the ECB probably owes something to a combination of factors. Some might argue that one of these could be the relatively healthy growth trajectory in ‘core’ euro zone economies, and, in particular, the recent buoyancy of Germany. However, today’s new ECB projections don’t suggest this to be a significant obstacle to further action.
The forecasts for euro zone economic activity point to sustained economic growth through 2011 and 2012. The mid points of the growth forecasts for the next two years, at 1.5% and 1.7% respectively, are solid but not particularly strong. More importantly, new forecasts for inflation anticipate consumer prices rising 1.8% in 2011 and by just 1.5% in 2012.
Mechanically, these suggest the ECB could have some leeway to ease policy if they are to meet their goal of an out turn that is ‘below but close to 2%’. Significantly, today the ECB reaffirmed its previous assessment that the risks to growth are to the downside but it changed its view of inflation from one in which risks were ‘slightly tilted to the upside’ to one in which risks are now ‘broadly balanced’. So, the new projections could have been used to support a more accommodative monetary stance than the ECB announced.
A more unsettling explanation of the events of the past couple of days is that the ECB sees its role as altogether more limited than the markets might judge it to be or the euro zone needs it to be.
To conclude, the build-up and disappointment of expectations about ECB policy initiatives is worrisome. The ECB has decided not to act pre-emptively against the risk of a further worsening of contagion concerns in spite of indications to the contrary in recent days. The initial market reaction has been reasonably positive because markets judge that liquidity will not be restricted further and bond buying might be stepped-up somewhat. It would be surprising if calm conditions were to become the norm in the weeks ahead. Instead, serious risks of renewed volatility in euro zone bond markets persist.
Content provided by: KBC Bank