Our national herald has now carried out his monthly task at his press conference without surprises marked by anticipated decisions.
I have nonetheless decided to compare his staff's economic forecasts with the decisions taken by the ECB to highlight the supposed consistency of the ECB's intellectual resources.
Let me first cite from Mr. Trichet's official talk.
The macroeconomic situation:
- The economic recovery in the euro area is on track, although it is likely to remain uneven.
- The euro area economy to grow at a moderate pace in 2010, in an environment marked by continued uncertainty.
- The Governing Council expects real GDP growth to remain moderate in 2010, owing to:
- The ongoing process of balance sheet adjustment in various sectors
- The expectation that the low capacity utilisation is likely to dampen investment
- That consumption is being dampened by weak labour market prospects
The monetary situation:
· Monetary analysis confirms the assessment of low inflationary pressures over the medium term & Inflation expectations remain firmly anchored.
· Together with the negative annual rate of growth in loans to the private sector, (…) the underlying pace of monetary expansion is moderate and (…) inflationary pressures (…) are low.
· The growth of M3 and loans to the private sector is likely to remain weak also in the coming months. Loans to non-financial corporations can be expected to remain weak for some time after economic activity has picked up.
· Banks have continued to reduce the size of their overall balance sheets over the past few months, but the challenge remains for them to manage this adjustment while ensuring the availability of credit to the non-financial sector
In short, the economic recovery is soft and the economy could contract again, and the ECB economic staff's own inflation projections are for 1.2% in 2010 and 1.5% in 2011.
Let us not forget that this is the same staff that became infamous under the sterling leadership of Juergen Stark for their ridiculously erroneous forecasts made in the summer of 2008, which led the ECB to hike key rates by 25 bps on 3 July 2008.
This is the same staff that has been "consistently" behind the curve, given its theoretical inability to account for the credit velocity and quality variables and its near genetic neoclassic proclivities.
If the economic forecasts are so uncertain, not to mention the danger of exogenous shocks (Greece, deleveraging), and if the ECB's only needle in its compass (according to Trichet himself), inflation, remains hopelessly stuck below the ECB's target range (1.80% to 2%), it would be only logical for the ECB's council of elders to adopt an even more accommodating stance (Refi at 0.50%, LTRO and QE) to fulfill their mandate. And that's leaving aside the humanitarian considerations vis-à-vis the Eurozone's current problems.
Well, here are the monetary policy changes announced by Mr. Trichet this afternoon:
· (The ECB) decided to return to variable rate tender procedures in the regular three-month longer-term refinancing operations (LTROs), starting with the operation to be allotted on 28 April 2010.
· The rate in the six-month LTRO to be allotted on 31 March 2010 (will be fixed) at the average minimum bid rate of the MROs over the life of this operation.
In other words, after deciding to eliminate 12-month refi operations and indexing the latest operation to future hikes in key interest rates, they decided that the next 6-month operation will aslo be indexed on the same basis as the previous one.
But, above all, by moving 3-month loans to a variable rate procedure, the ECB runs the risk that short-term rates will rise above the current refinancing rate of 1%, when the expiry of the first LTRO of €442bn at 1 July will drain so much cash from the market that the overnight rate (Eonia) may also climb from the current 0.32% toward the refi rate of 1%.
Given the additional uncertainty about the current 12-month LTRO and the upcoming 6-month operation, it seems absurd to claim that it is all just a matter of tightening the monetary screw. The Term Structure of short-term rates may make itself painfully felt in the coming months.
One last point to conclude: Although these measures were largely expected by investors, as confirmed by the moderate reaction of yields on German 2, 5 and 10 debt (despite the extra handicap of the better resistance of Greek bonds), we can only say...
Bravo to the ECB: after bringing your right foot forward, you have now in front of you, the deflationist trap threatening the Eurozone.
As such, we now view differently our biases in favour of Eurozone government fixed rate instruments, and now favour yield curve flattening positions.
We will shortly propose options strategies that make it possible to bet on a return of the 2-10 year German yield spread toward 180 bps or even 150 bps, which is just that much more comfortable to bet on given the current historic levels of 210 to 220 bps.
Disclosure: Long 20 years OAT Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds