• We expect Mario Draghi to sound slightly more optimistic at this month’s Governing Council meeting. It almost seems like a foregone conclusion that policy rates will be on hold.

  • Since last month’s meeting, there have been tentative signs that soft data has begun to improve, peripheral spreads have tightened further and money growth has picked up speed.

  • We expect a gradual economic recovery in 2013 and thus the ECB could be on hold for a very long time.


First signs that the economy has bottomed out

Since last month’s meeting, there have been tentative signs that the economy has bottomed out. Soft data has begun to improve, peripheral spreads have tightened further and money growth has picked up speed. Of uttermost importance, M1 growth increased from 5.0% in September to 6.4% in October – thus strengthening the signal of a rebound in growth on a six-month horizon. At a conference in Paris on 30 October, Draghi described the current situation as ‘a relative stabilisation of market conditions, and more generally of improved confidence about the stability of the euro area’.

In such an environment, the ECB Governing Council is likely to save its ammunition for later. Some doves in the Governing Council may argue for further easing but it is hard to see how the hawks can agree with this when there is good reason to believe that the economy has bottomed and monetary developments may have fuelled renewed concerns about the inflationary risks of the already very loose monetary policy. Overall, we do not expect any new measures and the wording may indicate that the ECB is becoming slightly more optimistic.

Further easing may eventually come in the form of an activation of the OMT programme. The announcement of the programme has, however, been so successful in bringing down sovereign spreads that the activation of the programme may never be needed. We believe that eventually some negative news from Spain (on banks, the housing market, fiscal consolidation or regional independence) may unnerve investors and we could see a mini-crisis prompting Spain to ask for help from the ESM and ECB. If not, the instrument may never be used. This would probably be one of the ECB’s biggest successes.

We anticipate a gradual economic recovery in 2013 and thus the ECB could be on hold for a very long time. We expect policy rates to be unchanged until 2015 when the ECB may begin to hike rates at a measured pace.

However, there is one caveat. Excess liquidity will decline when banks have the opportunity to return liquidity from the 3Y LTROs. The first date for early repayment is 30 January 2013. Excess liquidity is currently around EUR600bn. If it drops sharply, the ECB could counter this with further easing in February or March 2013. Excess liquidity will probably have to fall well below EUR200bn before rates are pushed up.