Thursday’s meeting of the governing body of the European Central Bank (ECB) happens as calls for the central bank to take further action to solve the euro zone debt crisis by acting as lender of last resort for troubled countries increase.
The committee is expected to keep interest rates on hold at the historic low of 1 percent, and hold back on further action, despite growing calls for the bank to resort to quantitative easing – buying government bonds in primary markets, like the Bank of England and the Federal Reserve. Its decision will be announced at 12.45 London time.
“(Mario) Draghi (the head of the ECB) can’t sit there and be idle at a time when we’re getting very, very bad news for the euro zone,” Carl Weinberg, Chief Economist, High Frequency Economics, told CNBC. “The economy could use an interest rate cut.”
He added that he believes Draghi is “not quite ready” for quantitative easing yet, but that February could herald such an operation.
There was better-than-expected demand for the ECB’s offer of unlimited three-year loans, known as long-term refinancing operations (LTROs), which were launched in December. However, evidence suggests that many of the banks which snapped up the LTROs are sitting on their new funds or depositing them back into the ECB rather than risk them elsewhere.
Commercial banks' overnight deposits at the European Central Bank hit a fresh highof 482 billion euros ($616.8 billion) on Tuesday as banks continued to keep their funds with the central bank rather than lend them or buy up sovereign bonds.
And while leaders are wrangling over the best way to solve the debt crisis, worries that the euro region will slip into recession this year continue.
The value of the euro has slipped to near 16 month-lows. Ratings agency Fitch warned Wednesday of dire consequences for the region if the ECB does not take more action.
“There remains a strong case for the ECB to embark on large scale asset purchases similar to the quantitative easing programs undertaken by the Federal Reserve and the Bank of England,” analysts at Credit Suisse wrote in a note.
They believe that the LTROs have a “reasonable chance” of success.
Monetary Conditions Loosening
The Euro Overnight Index Average (EONIA) interest rate – the rate at which banks lend to each other overnight - has fallen to similar levels to those seen in the first half of 2010, indicating that monetary conditions are loosening.
Auctions of Italian and Spanish bonds Thursday morning should indicate investor sentiment towards these countries, the euro zone’s third and fourth largest economies, which have struggled in recent months as yields rose on their bonds.
In the past, the ECB has bought up some of their bonds to help bring yields under control.
“We now don’t see a big effect on Italian or Spanish bonds when the ECB is in the market - it’s clear that the securities markets program was more efficient to begin with,” John M. Hydeskov, chief analyst at Danske Markets, told CNBC.
“They seem to like the use of non-standard measures, and we don’t really see them using standard measures going forward after the success of LTROs,” he added.
He believes that the ECB should introduce a “more formal” bond-buying program, by announcing the amount it will spend but not which countries’ bonds it will buy.
“The overall impression that is likely to be given is that the Governing Council remains worried about prospects for activity to a much greater extent than inflation, and while there may be some further measures to make the non-conventional operations more effective, it is highly unlikely to be a complete game-changer,” Paul Robinson, Managing Director and Head of FX Research at Barclays Capital, wrote in a note.
One of the most immediate issues facing euro zone leaders is the extent of private sector involvement in slashing Greece’s $200 billion plus debt.
The next large repayment of Greek debt is due in March.
Weinberg pointed out that the ECB is one of the holders of Greek bonds who may suffer if the troubled country defaults on its debt repayments, and that it may have to back up other institutions who hold them.
“There’s a real grey area over whether the ECB or the institution takes the hit,” he said.
He also warned that the true impact of a Greek default is difficult to predict because of the credit default swap (CDS) market.
“It’s a largely over-the-counter market – some gets clearing through exchanges but I don’t know what percent of the outstanding CDSs go through that.”
In the UK, the Bank of England’s Monetary Policy Committee is also expected to sit tight on the policy front at the conclusion of their January meeting on Thursday. Economists expect them to leave the door open for more action on quantitative easing in February.