The European Central Bank kept euro zone interest rates at a record low of 1.0 percent as expected on Thursday, leaving it poised to flesh out a revamp of its lending rules and give its view on Greece's escalating debt crisis.
With the euro zone's economic recovery still at a delicate stage, all 82 economists polled by Reuters correctly forecast the ECB would keep rates on hold for the 11th month running. Markets were little changed after the decision.
The focus now turns to the post-decision news conference where the bank's President Jean-Claude Trichet, flanked by Vice-President Lucas Papademos, will detail the decision and announce new rules governing what assets banks can swap for ECB loans.
"The decision to keep rates unchanged was fully expected," said RBS economist Silvio Peruzzo. "I think the economic conditions for the euro zone are aligned with the ECB's view that rates are appropriate."
"The focus is pretty much on the collateral policy changes. The market will try and pin down who are going to be the winners and who are going to be the losers here."
Trichet has already primed markets for the changes, which will include a Greece-friendly move to extend easier lending terms into 2011.
It will remove the danger of Greek government bonds falling off the list of what banks can swap for ECB loans next year, a risk that was growing with every rating downgrade until the ECB went back on plans not change its rules.
He has also promised a new sliding scale of collateral 'haircuts' — risk premiums it applies to assets used as security in liquidity operations to insure itself against a Lehman-like collapse of a bank.
A euro zone central bank source told Reuters last week that the ECB's new sliding scale would start at the top AAA rating, with haircuts increasing in severity as the rating declines. [ID:nLDE62O1AH]
The changes will end the immediate threat to Greek access to the funding mechanism but could create a headache for banks by effectively cutting the value of assets that are not rated AAA. With Greek debt the lowest rated in the euro zone, it could reduce the amount banks get for their Greek debt, reducing its appeal.
GREECE
The turmoil in Greece has been the main driver behind an 8 percent trade-weighted drop in the euro since December <EUREER=ECBF>, and an 11 percent drop against the dollar <EUR=>.
The cost of insuring Greek debt against default jumped to a new all-time high on Thursday, <GR10YT=TWEB> [ID:nLDE6351AE] a day after Greek banks asked the country's government for another 17 billion euros of aid.
The volatility comes in spite of an emergency rescue plan sketched out the EU late last month.
"The Greek story is still raging," said Deutsche Bank economist Mark Wall, who expects Trichet to be quizzed extensively on the rescue plan and the IMF's role in it — something he was originally opposed to.
"It is the lack of technical details of the rescue plan that is causing the markets to have doubts," he said.
Wall also has questions on the collateral changes.
"Where will the graded haircuts kick in? How significant are those haircuts? And does it make the ECB's collateral framework more or less accommodative on aggregate?"
At present the ECB differentiates between assets but makes no distinction between same-type securities rated at or above A-.
Nomura analyst Laurent Bilke thinks the ECB will find a way to balance the situation. "We assume that the ECB will 'sterilise' the expected effect of this regime change," he wrote in a research note.
"AAA-rated assets could see their haircuts lowered, those around A- could stay unchanged, while BBB- assets will likely experience sharper haircuts than currently." ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For graph on ECB interest rate increase expectations: http://graphics.thomsonreuters.com/10/04/EZ_ECBPOL0410.gif For graph of ECB lending to banks: http://graphics.thomsonreuters.com/10/04/EZ_ECBLEN0410.gif For story on possible scenarios to come out of meeting: [ID:nLDE6300IE] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
EURO TRASHED
The euro's decline has been welcomed by the 16-country bloc's exporters. Dirk Schumacher, an economist at Goldman Sachs, wonders whether the ECB will see it as helping hand for the euro zone's economic recovery.
"The decline in the euro is the other issue that should be on their mind, and to what extent it changes the outlook for growth and inflation."
"It has fallen sharply since the start of the year and if it stays at this level it is quite a nice stimulus."
Latest data suggest Trichet is unlikely to stray far from his frequently reiterated view that the recovery will be uneven and that the bank's record low interest rates are appropriate.
Manufacturing activity grew at its fastest pace in over three years last month and the region's dominant service sector at its fastest in two. [ID:nLDE6360HC]
But updated official figures also showed the euro zone economy stagnated in the last quarter of 2009 and unemployment hit 10 percent. <EUGDP=ECI>
"Leaving aside developments in Greece, the economic data flow has been relatively hawkish over the past month," said Nomura's Bilke.
"These developments are significant, in our view, especially the manufacturing output rebound… So there is probably room for some acknowledgment of these developments."
