ECB to Hold Rates as Crisis Abates, Oil Spikes

The European Central Bank (ECB) is widely expected to leave interest rates on hold Thursday, a week after banks took up more of its cheap loansoffered in another attempt to avert a crunch and calm financial markets.

European Central Bank
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European Central Bank

“We are absolutely certain that the ECB will leave rates unchanged this month,” analysts at Danske Bank wrote in a note to clients.

“The economy appears to have stabilized, financial markets are doing better and, most importantly, the ECB has just launched 3-year LTROs (long-term refinancing operation) totaling more than one trillion euro, so in Frankfurt they hardly see the need for further easing just now,” they said.

Instead, this month’s policy meeting will likely focus on the need for a third mass release of cheap loans.

Analysts are divided on the success of the LTROs, with many arguing that the ECB’s strategy is failing and that banks are not using the cash to lend on to companies in the euro zone.

“The banks are still hoarding huge amounts of money. The interbank market doesn’t work. The ECB is effectively the central counter party for the euro area money markets,” Marc Ostwald, strategist at Monument Securities told CNBC.

“Banks are basically making sure they have got enough money to pay down the debts which are going to be maturing. It leaves us effectively in gridlock, perhaps a better way of describing it is deadlock,” he said.

Carsten Brzeski, senior economist at ING agreed.

“While financial markets have calmed and tension in government bond markets has faded a little, credit growth still remains sluggish,” he said.

“Up to now, it looks as though the ECB has become the lender of last resort for banks and indirectly for governments, but not yet for the economy.”

The ECB will also release its quarterly staff forecasts, which are expected to show a slight upward revision of its inflation forecast. That will add to the cental bank’s reluctance to cut rates, analysts said.

Inflation in the euro zone remains above the ECB’s 2 percent target, and with the recent sharp rise in oil prices it may take longer than anticipated for inflation to come down.

Euro zone consumer price inflation hit 2.7 percent in February, compared to 2.6 percent in January.

“Surging energy prices are beginning to push inflation upward. On previous occasions this has caused the ECB to hike rates. We believe that (ECB President Mario) Draghi will abstain from this kneejerk reaction,” Danske Bank said.

Brzeski added the inflation forecasts for next year were also key as these were probably the single most important variable for any future rate change.

Greece to Overshadow Market Reaction

The specter of a Greek default will hang over financial markets on Thursday and nervousness over the Greek debt swap deadlineThursday evening will likely overshadow the ECB’s policy decision.

“Market reaction is set to be moderate if the ECB keep rates unchanged and does not change its easing bias too much,” Danske Bank said.

“If Draghi signals that the easing bias is gone due to improving growth prospects and increasing energy prices, we could see markets react with higher long rates and a EUR/USD strengthening,” Danske Bank added.

Greece’s finance minister Evangelos Venizelos has warned creditors to accept the bond swap offer as it would be the best possible deal.

Greece's six biggest banks have said they they will take part in the bond swap, which will see them take a 53.5 percent loss on their holdings of Greek government debt, but several pension funds said they would not.

Greece is optimistic that a 75-80 percent participation rate in the bond swap will be achieved, Greek media reported on Wednesday.

“If the participation rate is between 75 percent and 90 percent then the debt swap may proceed after consultation with official creditors. This may cause a period of substantial uncertainty until it is announced whether the debt swap will take place or not,” Danske Bank said.

“We expect markets to begin getting nervous if we approach the weekend without knowing the result of the PSI (private sector involvement) offer,” Danske Bank said.