AMSTERDAM, Netherlands—The European Central Bank (ECB) kept rates steady as expected and left the main refinancing rate at 1 percent. There were some significant developments underneath the surface though, which could explain the upbeat markets of last week and the week before.
Seven out of the 17 national central banks operating in the Eurosystem under ECB control decided to go ahead with the previously announced relaxation of collateral requirements.
To obtain loans by the ECB in one of the refinancing operations (including the by now famous Long Term Refinancing Operations or LTROs), banks must have eligible collateral that gets deposited in the ECB. In normal cases, banks would deposit EUR 100 ($132) worth or German government bonds, for example, and obtain EUR 100 loans. At the end of these repurchase agreements (repos), the banks return the loans and get back the bonds.
During the first LTRO in December 2011, which saw banks borrowing roughly EUR 500 billion ($660.35 billion) from the ECB, many other more risky government bonds such as Greek, Italian, and Spanish were posted as collateral for the loans. This collateral is more risky for the ECB, as in a worst-case scenario such as a Greek default, the borrowing bank would be bankrupt, and the bonds would also be worthless. At the end, the ECB would end up with the loss.
More Credit for the Real Economy
Last week saw another step in this progression toward ever more liquidity and fewer restrictions on collateral. Cheap financing will be accessible to banks that do not hold a large portfolio of government bonds to pledge. The seven central banks of mostly peripheral countries, but also France and Austria, will now also accept loans made to small and medium sized enterprises (SMEs) as collateral on behalf of the ECB. This opens the window for small banks to refinance directly at the ECB and channel that credit to the non-financial private sector. Riccardo Barbieri of Mizuho believes that this measure reduces the risk of a worsening credit crunch that would devastate small and medium firms, which account for the bulk of GDP and employment in most Eurozone countries.
There are signs coming out of Germany, however, that point toward a more optimistic first quarter. While actual industrial production numbers disappointed for December— declining 2.9 percent for the month on expectations of an unchanged print—the forward- looking factory orders won (1.7 percent vs. 1 percent expected). Spain and Italy also surprised on the upside.
The official Consumer Price Index (CPI) also only increased 2.1 percent year over year, which is pretty close to the long-term target level of the ECB and would accommodate further easing in monetary policy.
New Greek Drama
The euro had another volatile week, probably reflecting first optimism about ECB policy and also developments in Greece. The currency rallied from a low of $ 1.3027 on Monday to a high of $ 1.3322 on Thursday, roughly at the same time that the ECB press conference ended. Events in Greece were then responsible for the drop to $ 1.3212 on Friday, nonetheless ending the week in positive territory.
The Euro Stoxx index reflected this sentiment even more dramatically. It rallied from 2,490 to 2,542 on Thursday afternoon, only to give up everything and then some to close the week at 2,480.
Greek Parliamentary Vote Finally Passes
As it was expected, negotiations between Greece and the so-called Troika (the EU, ECB, and IMF) did not finally conclude earlier last week and were further delayed. At the heart of the matter is budget reform and if the official parties will agree to a haircut on the Greek debt they hold.
Greece faces a bond payment on March 20 and missing it would mean formal default after a seven-day grace period. Greece and the Troika have been at loggerheads for much of the recent weeks as the official parties are concerned that Greece is not actively trying to reduce the deficit and institute necessary reforms. Greece on the other hand argues that the debt load after a private sector haircut will still be too high and needs the official sector to participate.
There were hopes last Thursday when Greek Finance Minister Evangelos Venizelos went on record to announce that the Troika and Greece had reached an agreement. This was then denied on Friday by a conservative party official and sent the markets tumbling.
The Greek parliament voted on this issue Sunday at midnight local time, and the MPs decided to pass the measure. As lawmakers accepted the new austerity measures for a new joint EU-IMF bailout, violence continued to erupt in Athens.
The Week Ahead
This week, an advance estimate for Eurozone GDP will be released. Analysts expect a decline of 0.4 percent for the fourth quarter. Many countries will also release the consumer price index.
Greece will release GDP numbers and it will be interesting to see how much output the country lost with the hitherto implemented austerity measures.