The European Central Bank lowered its interest rates on Wednesday and extended its liquidity provisions, demonstrating that it is “willing to go far when acting within its core mandate,” RBC Capital Markets wrote in its weekly research paper, "Global Directions," on Friday.
RBC expects European rates to be cut 50 basis points in the next few months, according to the paper.
The ECB also demonstrated a reluctance to increase sovereign bond purchases, according to RBC. Analysts expect that any step-up the ECB does take will be a “modest increase in scale and ambition,” rather than a full-blown asset purchase.
“From a market perspective, the push toward a closer fiscal union and economic convergence of the euro area, alongside the necessary EU treaty changes, were certainly seen as steps in the right direction,” according to RBC. However, it’s unlikely that the EU summit held Dec. 9 will result in a real solution to the euro crisis area, the report continues: “Even if the 27 EU leaders (or even only the 17 EMU members) could find a common denominator for an agreement, markets would want to take a close look at the details and especially what they would mean for the ECB.”
While structural reform and fiscal consolidation are long-term projects, they are “the absolute crucial foundation for any improvement of the credit perception of euro area sovereigns,” analysts wrote.
One of the ECB’s key objectives is to retain primary market access for Italy and Spain, the main tool for which will be a “leveraged‐up EFSF,” according to RBC.
A large-scale intervention from the International Monetary Fund could prove risky, necessitating precautionary facilities for those countries. The European Financial Stability Facility has announced that it has launched a short-term funding program, which, RBC economists write, could be used to support those precautionary facilities. The IMF’s involvement will be enough to ensure “skin in the game,” but not enough to pose a serious risk to its financial capacity.
The main source of funding will likely be bilateral lending, RBC writes. This has happened before, but now “key stakeholders have shown that they want the Europeans to take responsibility for solving their own crisis.” RBC notes that if a European government lends to the EFSF, it counts as debt, but if its central bank lends to the IMF, it does not.
ECB President Mario Draghi insisted that it will not lend directly to the IMF, saying that the ECB is not a shareholder.
RCB doubts a significant long‐term tightening trend will arise anytime soon, and expects to see a strategic widening trend limited by European leaders’ commitment to containing systemic risks of the debt crisis.
“The EU summit is very unlikely to yield final agreements to resolve the debt crisis in the euro area,” RBC concluded. “We consider the disappointment potential with respect to the outcome of the summit as substantial and like to express this view via tactical shorts in SPGBs in small sizes.