Screech. Halt. About-turn.
Speculation is rising that the ECB will be left with no choice but to reverse its liquidity withdrawal measures on account of the European-debt crisis.
The latest bank to opine as much is Italy’s Unicredit. Here are the thoughts of chief economist, Marco Annunziata (our emphasis):
The ECB’s exit strategy may have led it up a blind alley—through no fault of its own. As the mishandling of the Greek crisis has triggered fears of a systemic crisis that might engulf the eurozone’s sovereign debt markets and financial sector, any acceleration in the withdrawal of liquidity is for now off the table, and prospects for rate hikes even more uncertain.
In fact, the ECB is now being asked to consider substantial purchases of government bonds as a last resort in case contagion intensifies. It would be extremely hard to justify such a move as aimed at offsetting either deflation risks or dislocations in sovereign bond markets. In fact, a strong case can be made that the market is finally repricing eurozone sovereign risks based on fundamentals, after a decade of irrationally exuberant confidence in convergence prospects.
ECB purchases of government bonds would then be a straight monetization of excessive fiscal deficits—generating overwhelming and fully justified opposition at least from the Bundesbank and the German public. The ball is in the governments’ court: they need to signal and communicate clearly and convincingly their determination to put fiscal balances back on track.
Greece in particular will need to signal a greater degree of ownership of the adjustment effort ahead in order to rebuild market confidence. And the eurozone needs to demonstrate far greater cohesiveness, speed and decisiveness in addressing crisis situations.
The door is locked, there is no exit; the ECB is trapped, forced to sit idle at the table as governments argue and haggle their way towards a solution and possibly being asked to inflate the debt problem away—its own version of hell… Hard to say how long this will last—recent developments do not bode well—and the ECB can only hope inflation remains subdued for as long as possible.
Get that? There is no exit.
Furthermore, because any liquidity reversal from the ECB would clearly be linked by the market to a need to monetize European deficits — rather than fighting inflation — there is only one possible consequence for the euro.
BNP Paribas’ analysts put it nicely:
Last year’s 1yr allotment of around EUR450bn was a milestone for risky assets. The reason why it did not hit the EUR to a large extent was that it substantially contributed to a reduction in risk premia. At this stage, the ECB still wants to remove excess liquidity but the market is speculating that it may actually have to do the opposite, which would bring the EUR under even bigger pressure this year.
Related links:
Greek collateral damage (after all) - FT Alphaville
ECB liquidity monster demands good euro collateral, soon – FT Alphaville
Trichet: ‘Default is not an issue for Greece’ - FT Alphaville
‘This might just be one of the most important communications by the ECB in its short existence’ – FT Alphaville