A relatively uneventful meeting as expected, with no fresh hints on how the exit strategy will move forward. The most interesting part of the conference, in my view, is where it brought to light some of the trickiest landmines ahead--Mr Trichet elegantly sidestepped them in the Q&A, clearly hoping they will not really be encountered in the path ahead.
Greece featured prominently, and Trichet delivered a message of tough love: (1) collateral rules will not be changed for any single country; and (2) being part of the eurozone is help in itself, the issue is not help but the necessary adjustment measures which in any case need to be taken.
It was a very carefully crafted message, emphasizing that Greece (and others) needs to adjust for its own sake, while avoiding the question of whether financial help might be forthcoming if needed--where indeed governments, and not the ECB have the last word. Asked about the risks of spillover from Greece, Trichet emphasized that Greece accounts for less than 3% of eurozone GDP. That, however, is not the issue--the issue is how lack of market confidence in Greece could spread to other "fiscally challenged" countries, which might have very serious consequences for the eurozone's financial stability and growth prospects.
I remain of the view that this is a nerve-wrecking game of chicken, albeit probably a necessary one: EU authorities are putting a lot of pressure of Greece to cajole into serious adjustment, but if a rescue turns out to be necessary, a rescue operation will be mounted. The IMF is already providing technical assistance.
To conclude on Greece, I think we face at least a few more months of high volatility with risk that spreads might move significantly wider; after that, Greece will provide a very interesting opportunity.
The other tricky issue relates to the liquidity withdrawal and the exit strategy at large. Trichet confirmed that liquidity will remain ample throughout Q1, keeping EONIA rates at the current extremely low levels. From April onwards the ECB will start draining liquidity. With the Refi most likely on hold, will the draining of liquidity amount to a tightening of monetary policy? In my view absolutely yes, as short term rates will rise, moving us away from the de facto zero interest rate policy. It would be an appropriate move in our baseline scenario, but I think the ECB should call a spade a spade and abandon the somewhat artificial distinction between "technical" liquidity measures and monetary policy proper. However, it will be particularly hard to take liquidity out of a two-speed banking system where some banks are still heavily dependent on ECB support. Trichet today seemed to suggest the ECB can phase out the non-standard measures while still providing enhanced credit support to banks--but it looks like a very difficult juggling act to me.
For the rest, the ECB's macro outlook remains cautious and dovish, with a moderate and fragile recovery, and no meaningful inflation pressures over the next two years.
