ECB to face Greece questions, hold rates

All eyes will be on what the European Central Bank is willing to do to help Greece when it holds its monthly policy meeting on Thursday, with interest rates expected to stay on hold ahead of a major funding operation later this month.

ECB President Mario Draghi may be tight-lipped on the matter, however, with the Greek situation still unresolved.

Markets will also be looking for hints on whether the ECB is ready to cut rates from 1.0 percent to new record lows in the coming months, or if some recent positive economic news has been enough to put the bank in a wait-and-see mode.

While it is due to carry out a second low-interest, three-year loan operation later in February after a blockbuster 489 billion euro offering in December, the bank is expected to refrain from announcing new measures.

Francesco Papadia, a top ECB official, hinted on Wednesday that the central bank could wait, saying bank liquidity concerns had all but disappeared thanks to the ECB's December three-year loans, adding that he was tempted to declare 'mission accomplished'.

Analysts also said the central bank could relax a bit.

"There is very little incentive for the ECB to do anything or say anything. It wants to see how things play out," said Societe Generale economist James Nixon.

"The ECB has already done a lot, and they have the next three-year LTRO (long-term refinancing operation) at the end of the month," Nixon said.

With unlimited central bank liquidity, the ECB has pushed overnight market rates well below its main refinancing rate and its deposit rate, currently at 0.25 percent, acts as a floor for money markets.

But with the threat of a Greek insolvency casting a long shadow across the euro zone, Draghi will not go as far as some economists and declare the crisis over, even if the worst does turn out to be in the rearview mirror.

The risks have not disappeared and thus the ECB is seen revealing little about its plans regarding Greece and the 50 billion euros worth of Greek government debt it holds.

Sources have told Reuters the ECB is divided over whether it should forgo its profits on the paper when private investors are pushed to accept a cut of about 70 percent in value. Draghi will be asked about this, but he is unlikely to reveal anything more than last month, when he repeatedly dodged the question.

Even if the central bankers agree on a course of action, they will want to wait until it is signed and sealed before revealing their part.

After all-night talks with officials of the EU and the International Monetary Fund, Greek leaders failed to agree on a reform and austerity program, forcing its finance minister to go to Greece's financial backers with an incomplete deal.

In the meantime, the ECB could choose to feed the markets some details on the impact of changes to the collateral it accepts in return for access to its funds.

Draghi will also face questions about the central bank's bond-buying programme, but economists expect him to give little away even as the ECB has wound down the controversial program.

"The topic of the ECB's bond purchases has been settled," Nordea analyst Anders Matzen said. "The issue of outright bond purchases should be on the backburner."

Economy Perking up

Since the beginning of the year, some business surveys have instilled hope that the worst of the sovereign debt crisis has blown over and the euro zone economy is perking up. But there is enough doubt to keep the ECB on its toes.

European shares hit a new six-month high on Wednesday, with cyclical stocks extending a strong run as investors became more confident that economic growth would boost company earnings and eclipse concerns about Greece.

However, with the ECB having warned of substantial downside risks to growth and the economy only slowly pulling off the ropes, the central bank could signal further easing is underway.

Analysts are divided on the chances of a March move to record-low interest rates, and their task of reading the monetary policy tealeaves has been complicated by changes to the ECB's personnel recently, as well as the fact that they have spoken relatively rarely in public.

"We expect the ECB to ... signal a rate cut in March," Marie Diron of Oxford Economics said. The ECB will unveil its latest set of staff economic forecasts next month, which could see a further cut inflation estimates for the next two years.

However, other analysts said the March 8 meeting comes so soon after the ECB's February 29 liquidity operation that the bank will want to wait longer than that before touching rates, which could already have reached their floor.

"I expect a further improvement in indicators in the euro zone in the next couple of months. This will be enough to convince the ECB that they can be on hold," Matzen said.

Were Draghi, for example, to omit the word 'substantial' from the downside risks the ECB sees, this would be taken as indicating a smaller chance of a future rate cut.

However, more likely is that the ECB will make few changes to the wording of its policy statement as there are mixed messages in the data, with the latest monetary figures dismal.

"The bank lending survey and money supply numbers continue to be pretty ugly," Societe Generale's Nixon said. "It is not an exclusively rosy picture, it bodes for caution at this stage."

[Source: By Sakari Suoninen, Reuters, Frankfurt, 09Feb12]

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