ECB and BoE decision previews

With central bank decisions from the ECB and BoE and supply in France and particularly Spain, markets will have a significant amount of information to digest.





Following last week's changes to ECB collateral eligibility that affect ABS (which is in itself credit easing), it is likely that the ECB will be able to cut rates today in line with expectations. The reason for not moving in June was simply not to take the pressure off EU leaders to get a deal of some type done. The Summit result was a step in the right direction as far as the ECB are concerned, and has been broadly applauded by Draghi already.

As such, the ECB can now react to the recessionary conditions and lower inflation risks knowing also that a failure to ease would undermine the improvement seen post Summit. We expect the ECB to ease by 25bp on the refi rate, but we think there is scope for a 50bp easing too. At the margins the probability of a 50bp easing has risen given that the ABS collateral easing was offset, as far as ECB balance sheet risks are concerned, with a tighter framework for government guaranteed bonds which should please the Bundesbank, if such a thing is possible. The deposit rate should also be cut to perhaps 10bp or so, rather than zero, to keep money markets functioning.

The prospect of much lower EONIA rates rests on a deposit rate cut, and while this is highly feasible, the arguments for and against boil down to technical factors in keeping money market funds and OTC markets functioning rather than macroeconomic factors.

 Is another LTRO on the cards today?Collateral changes announced over the past two weeks could suggest that something is brewing at the ECB with regards to non-standard measures. As highlighted earlier, the ECB should reward the summit with easing, but another LTRO would in our view be a step too far at this juncture because:

• It would take significant pressure off European policymakers where the moral hazard risk is still material; basically a view that politicians need a foot on the throat to get on with required reforms;
• Bank liquidity needs are covered for this year, meaning that the bank funding argument is not strong yet;
• One of the positive steps taken at the summit was to weaken the sovereigns-banks nexus and another LTRO would make markets more sceptical medium term about the effectiveness of that policy action;
• The transmission mechanism remains dysfunctional and the weak credit demand makes the argument for further liquidity for lending even less compelling; and
• Results of the next Bank Lending Survey will be seen at the end of this month, so there is something of an information vacuum on the size of the malfunctioning within the transmission mechanism.

Long Silver, Long CEDC no hedge in place - as risk bullish as we've been in all of 2012 so far.