Tuesday, February 22, 2011

The ECB is becoming more hawkish

There has been an increase in the hawkishness by some ECB members, be it Bini-Smaghi last week or Mersch today . With the next ECB meeting being one week away, the ECB council seems to be moving towards the view that inflation risks are rising whereas the recovery becomes more sustained - at least in the core countries and given the relative size, also for the Eurozone average. It remains my opinion that the ECB will raise rates by June (see A higher ECB repo rate by June dated Feb 2) but keep liquidity provision ample. As the chart below shows, the peripheral markets have calmed down. 10y Spanish, Italian and Belgium yields have stopped rising and moved in a range over the past months.

10y peripheral yields have stopped rising, except in Portugal
Source: Bloomberg

Only the Portuguese situation has continued to worsen. To me it looks like the other Eurozone countries are trying to force Portugal into a bail-out while at the same time announce the overhaul of the EFSF. Such a solution could - if done properly - lead to a further calming in the peripheral crisis. Furthermore, an overhauled EFSF would be acting like a second monetary institution alongside the ECB but effectively be in charge of long-term peripheral yields. As a result, the ECB can concentrate again on its main policy tools - the repo rate and liquidity provision.

Accordingly, my basic views still hold:

Policy tool


Expected stance

Repo rate (ECB)


Less accommodative

Liquidity provision (ECB)


Ample liquidity

Peripheral bond yields (EFSF)


Less restrictive

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