We expected today’s Governing Council meeting to focus heavily on the provision of bank liquidity, and, in this context, the decisions were bolder than we had expected. In particular, there will now be two three-year LTROs (longer-term refinancing operations), and a halving of reserve requirements (from 2% to 1% of eligible deposits, which apply to about EUR10trn of deposits). Reserve requirements currently amount to about EUR206bn, so this is a significant increase in available collateral to banks.

The economic assessment remained downbeat, and we see a strong likelihood that the next set of staff macroeconomic projections – due to be published at the time of the 8 March 2012 Governing Council meeting – will be revised down significantly. For example, the midpoint for 2012 real GDP was revised down from +1.3% to +0.3%, whereas our latest projection is -0.2%. The 2013 GDP projection was 1.3%, similar to our expectation of the staff projection, but lower than our BarCap forecast (1.0%). Meanwhile, the 2012 HICP midpoint inflation projection was revised significantly higher to 2.0% from 1.7% in the previous September staff projections, as the ECB took account of higher indirect taxes. While similar to the BarCap forecast (2.0%), this was still a stronger revision than we had expected. However, the 2013 HICP inflation projection was only 1.5%, in line with our expectation (but this assumes a stable path for commodity prices and no further major indirect tax increases).

Overall, if our significantly projections for economic activity hold true, then the Governing Council is likely to continue to be surprised on the downside concerning 2012 activity and so, in our view, would probably continue to lower the policy rate in Q1 (our baseline is still 25bp reductions in January and February, taking this to 0.50%). That said, Mr Draghi stressed that the discussion on monetary policy had been between those who had wanted a 25bp cut today and those who did not (ie, no-one pressed for a 50bp reduction). While we find this somewhat surprising in the context of such weak business confidence, nonetheless, the relatively small range of discussion probably stems from the fact that current inflation is relatively high and that the 2012 projection was revised up 0.3pp. Overall, this still implies a relatively conservative monetary posture and illustrates that there is still uncertainty about how ready the Council will be to announce a further 50bp of interest rate reduction during Q1 (although Mr Draghi said, in response to a question on whether there might be a floor on the main policy rate, that “we do not pre-commit”). Meanwhile, Mr Draghi sounded an orthodox line concerning asset purchases, thereby dashing expectations in some quarters that the ECB might be prepared to embark upon a much stronger bout of asset purchases.

source: BarCap