ECB moves constitute boost for Greece

The European Central Bank’s decision to strengthen the measures taken last June by further cutting key intervention rates and initiating a purchase program for asset-backed securities and covered bonds may not have a direct, strong impact on the Greek economy, but it will likely lower the country’s cost of borrowing from the markets, significantly reducing the chances for a third bailout loan and saving the coalition government from political suicide.

ECB president Mario Draghi cited downside risks to inflation and weak economic data in theeurozone to justify the new unexpected measures. During  last Thursday’s press conference “super” Mario also repeatedly said the measures were predominantly oriented to credit easing.  Several market participants expect the measures to weaken the euro and further compress sovereign bond yields, especially in euro periphery. Initial price moves in the euro vis-à-vis the dollar and other currencies and the bond yields appear to be in tandem with expectations.

Assuming the above expectations are met in coming months and quarters,  the impact of the weaker euro in the Greek economy may not be that significant.  The relatively small size of the export sector and the composition of exports limit the benefits of the slide in the currency and the likely pick up in economic activity elsewhere in the Eurozone. At the same time the price of some imports, such as oil, will likely go up,  perhaps offsetting the boost from the anticipated GDP recovery, leading to the containment of imports. Other things held constant,  the country could see a limited positive effect in its trade and services balance from the weaker euro but will not be sizeable in our view.

Moreover, we don’t expect the ECB’s measures to unlock credit in the Greek market in the next 10 months or so. On one hand, demand for bank loans from creditworthy retail and corporate customers is very weak and is expected to strengthen slowly at best, assuming the economy picks up steam in the next few quarters. Any event or policy action which may disappoint expectations could undermine economic activity and the demand for credit. On the other hand, the Greek banks may have to face more headwinds ahead as they try to cope with bad loans, sell assets and fill any capital gaps identified by the ECB’s AQR and stress tests within a reasonable period of time. In addition, they have to continue their efforts to borrow less money from the ECB with tens of billions of euro in bank bonds carrying government guarantees being disqualified from the ECB’s collateral transactions next March.

Therefore, the immediate benefit to the Greek economy from the ECB’s measures seems to be the renewed slide in sovereign and corporate bond yields. The country’s 5-year bond issued last April to yield 4.90 percent until maturity saw its price rise to a new record high on Friday, driving its yield to 3.8 percent. Analysts pointed out this level is close or even lower than the comparable cost of funding from the IMF. The yield on the 10-year bond fell to 5.56 percent on Friday.  

Of course, the ECB’s measures alone cannot help solidify and produce bigger price gains, leading to lower bond yields without Greece’s commitment to fiscal discipline and reforms and a return to growth.  However, markets seem to assume that public finances will improve further in 2014 and the economy will slowly exit the six-year recession this year. The slide in the Greek yields may accelerate in the next few months if  market expectations are met and debt relief talks between the government and the EU bear fruits.

There is no doubt Greece should try to capitalize on these positive developments and raise an additional two to three billion euro from the markets before the end of the year.  A high-level government official was quoted as saying during the talks with the troika in Paris that the country plans to sell 7-year bonds before end-2014. We would not be surprised if Greece paved the way for  this or any other issue by selling 18-month treasury bills to the market prior to this to fasten the de-escalation of  yields, given the strong demand. It is also known Greece plans to re-open the previous issues of 3-and 5-year bonds and swap them with T-bills for 1 billion euros or more.  Local banks are expected to participate in the swap which is not seen adding to the country’s borrowing.  

By lowering the cost of funding, the ECB helps Greece both manage any liquidity gap which may arise due to delayed payments by the EU and the IMF till the end of the year and close further the financing gap for the 2015-2016 period. The gap is estimated now close to 11 billion euros if one includes the amount of 1.5 billion euros from the sale of 3-year bonds and assumes Greece meets the program’s primary surplus and privatization targets in 2015-2016. It could be even smaller if  the country builds a smaller amount for cash reserves than projected in the program. We also note the remaining 11 billion euros or so for the recapitalization of local banks which may not be used after all, following the ECB AQR and stress tests.

Draghi and the ECB may or may not reverse the apparent de-anchoring of inflation expectations in the eurozone, following the latest measures. It is more likely though they will be more successful in lowering Greece’s borrowing costs, facilitating full market access down the road and rendering a deeply unpopular third bailout loan unnecessary.

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