Welcome back to the peripheral Europe credit crunch, Draghi
The rise in borrowing costs in the real economy should galvanize the ECB next week.
There has been the re-intensification of the peripheral European credit crunch, courtesy of poor economic growth, Italy, Berlin party-pooping and now, surely, Cyprus. Despite a fall in peripheral sovereign spreads, borrowing costs to non-financial corporates rose in Italy and Spain, according to ECB data compiled before the Italian election result...
Food for thought for Draghi at next week's ECB meeting, especially as this Bloomberg Brief chart highlights that under a traditional “Taylor Rule”, estimating the reaction function of the European Central Bank, policymakers should cut the "policy rate to effectively zero in the near term and consider more aggressive action to support growth in the entire euro area".
Here is the Credit Suisse house view on what to expect at the ECB meeting:
Refi rate cut: The decision on cutting the Refi Rate is likely to be discussed, but our central view is that the ECB does not actually pull the trigger next week. We expect the ECB to lay the ground work for a cut later in the quarter or when they next re-evaluate the staff economic projections. We maintain our overall long bias in the front end. In terms of negative deposit rates, although less likely near term. A cheap way to play this is via FRA-EONIA wideners in the 2y sector.
Collateral framework widening: in our view innovation either in the haircuts or the eligible pool of collateral is likely at the next meeting. Although Draghi publicly dismissed this last month, we think there is general discussion at the ECB around designing ways to increase availability of credit to SMEs. A material relaxation of collateral requirements is likely to lead to tightening of peripheral spreads and tightening of intra-curve bases.
LTROs: we do not expect the ECB to announce further LTROs at next week’s meeting, as excess liquidity in the Eurosystem is still ample (over €450bn) and banks have started to repay LTRO refunding. We expect the ECB to keep this option open but do not expect this to be an imminent option.
OMT activation: the line on the OMT is likely to remain as is – effectively the ball is in the sovereigns’ court. Last month President Draghi subtly moved the goal posts on eligibility of OMT for programme countries, stating that a country needs to be already issuing across the curve consistently before it is eligible for the OMT. The recent widening in peripheral spreads is also likely to garner more questions next week. Given the recent uncertainty around the formation of an Italian government we hold our view that Italian bonds are further away from OMT eligibility than Spain. We hold our short 10y Italy versus 2y Spain recommendation.