If we look at it from a broad European or market perspective (rather than that of Ireland), ECB press conference should have been a relatively dull affair. The ECB will be happy that recent survey data seem to confirm that euro area economic activity appears to be bottoming out, that inflation has fallen to its lowest level in over two years and Eurozone money markets continue to ‘thaw’ as risk sentiment improves.
Admittedly, we remain some considerable distance from the point where conditions in the ‘real’ economy or financial markets could be described as having completely ‘normalised’ but there is a widespread recognition that any recovery process will be an extended one. For these reasons, there was little expectation of any significant policy initiative today—ECB policy rates were as expected left unchanged and Mr Draghi might have hoped to do little other than present a cautiously positive assessment of work in progress.
In a low key, but frequently awkward press conference today, Mr Draghi spent most of his time trying to deflect repeated questions about what looks to be a significant change to the funding mechanism for that portion of Ireland’s banking debt that relates to the Irish Banking Resolution Corporation (the wind down vehicle for the former Anglo Irish Bank and Irish Nationwide Building Society). The significance of this development means we discuss it at some length below but Mr Draghi also made a number of other important comments in relation to the ECB’s current policy stance that merit attention.
In very broad terms, the ECB’s assessment of current economic conditions in the Euro area hasn’t changed markedly in the past month. The ECB now feels weakness ‘is likely to prevail in the early part of 2013’ a slightly less negative phrasing than a month ago. The ECB thinks that the various actions it has taken ‘will in the end find their way through the economy’. As a result, Mr Draghi ‘foresees a gradual recovery in the second half of
the year’.
The expectation that the euro area will improve as 2013 progresses means the ECB doesn’t envisage cutting interest rates further at this point but the door is not firmly shut on further easing if circumstances deteriorate. A key element of Mr Draghi’s presentation was an emphasis on the ECB’s determination to maintain an accommodative stance. This stems from an appreciation of the still fragile condition of the Euro area economy and the fact that the ECB continues to see risks around the economic outlook weighted to the downside.
More importantly, Mr Draghi’s comments seem to suggest some emerging concerns that recent signs of stabilisation in economic conditions could be threatened if either a firming in money market rates or the strengthening in the exchange rate of the Euro of late were to go much further. We would interpret Mr Draghi’s comments today as relatively dovish. The ECB recognises any turnaround in economic or financial conditions could easily be reversed and as such emphasised its commitment to ensure policy remains accommodative. If financial conditions were to tighten materially either through a further firming in money market rates or a significant rise in the euro’s exchange rate, Mr Draghi hinted today that the ECB would contemplate offsetting action either through liquidity measures or possibly even through easier policy.
At very least Mr Draghi is engaging in verbal intervention to stem unwanted movements in money market rates and the euro.
Although Mr Draghi tried hard to avoid the issue, there is little doubt that significant changes in the funding mechanism for that part of Ireland’s banking debt that is related to the former Anglo Irish Bank and Irish Nationwide dominated proceedings today in Frankfurt.
While Mr Draghi was technically correct to say that the ECB didn’t have a decision to take today in regard to this matter, the reality is that the more detailed announcements made today in Dublin represent the outcome of a prolonged and sometimes tortuous process of deliberations between Dublin and Frankfurt.
In conclusion, the emerging details of the new structure are probably more favourable to Ireland than most had expected. By reducing official funding requirements for the next ten years and marginally easing the scale of budget adjustments envisaged in the next couple of years, the new mechanism improves Ireland’s prospects of exiting the bailout and also increases the likelihood that the Irish economy will return to a healthier growth trajectory in coming years. As such, it should underpin positive market sentiment towards Ireland. Reflecting this, Irish bond yields fell sharply on Thursday afternoon with the 10 year yield dropping around 17 basis points, its lowest level since 2007.