KEEP AN EYE ON - FIRST ECB AND THEN THE FED

By Ruma Dubey

Italian Mario Draghi is the man to watch. All eyes are on the ECB chief – will he cut rates or no?

The big news awaited is from the European Central Bank (ECB). The Indian markets are rallying upwards today on hopes that RBI, our desi ECB, will cut rates on 18th June. And the European markets opened up on hopes that its ECB will signal some stimulus for growth in the beleaguered EU zone.

But the big question is really whether ECB will do anything to stimulate growth or will be it a status quo. Like the pressure on RBI to act, the pressure is immense on ECB to be the knight in the shining armour and rescue the EU. Yet, will Mr.Mario Draghi give in to the pressure?

There is really a very small section of analysts who believe that ECB could cut borrowing costs, which as such is at a historic low of 1%. Majority confer that, and rightly so, that the ECB meet will be status quo, no decision will be made. The ECB wants to convey to the EU chiefs that has done what it could, used all the possible arms in its arsenal to prop up growth but now it is time for them to act, for them to respond to the current crisis. Sounds so very familiar – uncanny resemblance to our Indian story of RBI and the UPA Govt.

Just as RBI can only either cur rates and make borrowing easy or buy bonds, the ECB too has the same route. But it has done all that which it could – cur rates, buy bonds and even make lending attractive. Beyond that, call it lack of creativity or lack of will, there is really nothing more it can do.

Rates at 1% are indeed at a historic low, yet the crisis only seems to deepen. EU retail sales fell 2.5% on a YoY and the mighty Germany is also signing signs of fatigue as its orders from the manufacturing sector fell 1.9% in April. Unemployment remains around 20% in Spain and Greece. So rate cuts have not really helped matters. It also pumped in more than 1 trillion Euros through two long-term refinancing operations (LTROs) in December and February. This was really a huge stimulus to lending as it was obscenely cheap rates. And by cheap rates, we mean really cheap, averaging at 1%. Banks have the option of paying back all or parts of the loans at any time after one year. This is a no-strings attached kind of loan, meaning banks can invest or lend the money as and when and to whomsoever. This helped stabilize the banking system but only that cannot be the solution every time. There is no LTRO3 on the anvil.

That leaves it with the option of buying Govt bonds. But since May 2010, the ECB has bought bonds to the tune of 220 billion Euros. Since then, buying has been shelved and its rules do not allow it to finance Govts.

All this might ultimately be a damp squib and the ECB might in all probability sit on its hands. There are the Greek elections on June 17th and the European summit on 28th June. Thus Dragchi would want to wait and watch before taking any action. After all, if things do not pan out well in the coming days, support from ECB will become a necessity in the form of a rate cut or another LTRO.

After Europe, we will need to turn our eyes to North America; so while we will be sleeping, Fed will release its report on the economic roundup of the region which will give important cues for the road ahead. And as we slip into deeper slumber, Fed Vice Chair Janet Yellen is scheduled to speak at Boston and tomorrow, the Fed Chairman Ben Bernanke, will testify before the Joint Economic Committee. “Operation Twist”, sale of shorter-dated Treasurys and the purchase of a similar amount of longer-dated notes and bonds, which expires by the end of June is expected to be extended. As usual, there is talk of QE3 and we could get indications from Yellen’s talk.

Well, those were the days, when one had to watch just Dalal Street. But today, as the world grows smaller, we need to keep a watch on the European market streets and Wall Street. Price to pay for a flat world.