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Wednesday, 23 July 2014

IFR Comment: ECB - Liquidity signals vs forward guidance

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ECB speakers have highlighted a desire to have much stronger forward guidance than the current stance that policy accommodation will remain for as long as is necessary/needed.

Divyang Shah

Divyang Shah, Senior IFR Strategist

Communication has not tended to be a problem for the ECB and adding a few bells and whistles to the existing language should be straightforward. But the real question is whether this will be effective at a time when money markets are also reacting to the excess liquidity outlook.

Remember that excess liquidity currently is still ample at above €250bn so much of the concern rests on continued repayment of 3-year LTRO loans. At the current trend of repayments (and taking into account autonomous factors) we could see excess liquidity dip below psychological €200bn this year. Instead of forward guidance we think it might be better to indicate/announce a willingness to conduct further LTROs.

The new LTROs could be of a longer maturity of 3-5 years, be directed at ABS of SMEs and even combined with the use of EIB guarantees for SMEs.

In addition the ECB could change its own collateral rules in accepting SME collateral by lowering haircuts.

The advantage of this liquidity signal is that it would:

1) soothe market concerns over the liquidity outlook and

2) highlight that the ECB bias is to provide continued support to the economy and SMEs in particular.

We don’t expect the ECB to cut rates further with the emphasis being on trying to make existing policy more effective.

Whatever happens the main task today is to provide a dovish signal to the market and allow the money market curve to flatten. If this fails then we could see a shift in emphasis toward liquidity based measures.

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