EU: A Message to the Eurozone
[Teaser:]The European Central Bank is definitely on it way toward unwinding its liquidity support for the eurozone, but the exit will likely be highly nuanced.
Analysis
Following a decision by the European Central Bank’s (ECB) Governing Council to maintain interest rates at a historic low of 1 percent,ECB President Jean-Claude Trichet provided more details March 4 on the bank’sslow <link nid="155388">unwinding of liquidity support</link>for the eurozone.To what extent the ECB intends to continue on this path is unclear;what is certain is that the bank wants to send a clear message to the monetary union.
Trichet announced at a press conference that the final six-month operation to provide unlimited liquidity, [beginning on March 31?], would not use a fixed rate of 1 percent but would instead be "indexed"-- meaning that the rate would rise based on what the ECB does with interest rates. Trichet also announced that for the next three-month liquidity operation,[beginning?] in April, banks would have to competitively bid for a set amount of liquidity instead of receivingan unlimited amount (for eligible collateral) at a fixed rate of 1 percent.
However, one-month and one-week liquidity operations will continue to be unlimited (assuming appropriate collateral) until at least Oct. 12.Additionally, the ECB would[will?] loan some of the covered bonds it has purchased during the economic crisis back to eurozone banks, providing them with additional collateral with which to draw liquidity from the ECB. This means that demand for government bonds will continue to be propped up by liquidity provisions (a process described in detail in the interactive below), which will continue to help troubled eurozone countries such as <link nid="154185">Greece</link>.
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If anything, the March 4 announcement shows that the ECB is definitely on it way toward unwinding it liquidity support but suggests that the exit will be highly nuanced. It will certainly be contingent on developments within the eurozone, particularly those related to sovereign-debt issues in <link nid="153976">Southern Europe</link>.While it is unlikely that the bank would knowingly change its liquidity policy in such a way as to endanger the eurozone financial system, it is clear that the ECB is urging eurozone banks to begin thinking about alternative sources of funding, which means that <link nid="151602">eurozone governments</link>should do so as well.