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Aperiodic n15/227 13 July 2015

ECB Business unusual

Were it not for Greece, the ECB would be enjoying a gradual, domestically-driven, QE-boosted Eurozone recovery while keeping a cautiously optimistic tone at its regular policy meeting on Thursday. Instead, the focus will remain firmly on the ECBs next move on ELA.

A gradual, step-by-step increase in ELA looks likely, starting this week, conditional on the implementation of prior actions by the Greek government. Either way, capital controls are expected to be maintained.

With a deal being struck in the 20th hour of the EU

summit and several political hurdles still to be cleared, the ECB's dilemma remains. It has been trying hard to distance itself from political decisions on Greece, yet its role as a last-resort liquidity provider to Greek banks will remain pivotal. Last weeks decision to maintain ELA while adjusting collateral haircuts by an undisclosed amount was a political decision, no matter the official justification.

So what comes next? During the latest negotiations, Draghi was said to be waiting for a strong political commitment before extending ELA. In the end the Eurogroup will work with the Institutions to swiftly take forward the negotiations following the usual national procedures, including on the matter of so-called bridge-financing. Some elements of the privatisation funds and bank recapitalisation have emerged, although key details are still lacking.

We believe the ECB will err on the cautious side before it makes a final decision. The final approval of a third Greek bailout including debt re-profiling (after the first programme review) will be conditional on the implementation of no fewer than six reform bills by the Greek government within the next few days, before the national approval procedures can start in several countries including Germany. On balance, the ECB might initially maintain the ELA cap at around EUR89bn while signalling that an increase would come later,

after the reform bills are passed. Assuming this is the case, a large enough ELA lift could be decided by the end of the week, helping Greek banks to operate even under capital controls. Meanwhile, the Eurogroup will need to agree on the modalities of bridge-financing, which should reach EUR7bn by 20 July and EUR5bn by mid-August.

Greek Emergency Liquidity Assistance likely to be raised further

Source: ECB, Crdit Agricole CIB

The most crucial aspect of the deal when it comes to the ECBs decision will be how the EUR50bn privatisation funds are designed, monitored and used for Greek bank recapitalisation, for which about EUR25bn is said to be earmarked specifically. In particular, it looks unclear whether the latter will entail a bail-in element within the new financial supervision and resolution framework. On the bright side though, EUR10bn will be made available immediately in a segregated account at the ESM. This should support a pragmatic and swift decision by the ECB. On the negative side, the agreement foresees a comprehensive assessment by the ECB/SSM after the summer only, suggesting the full process could take time to be completed. The ECB could find a compromise by raising ELA by a moderate amount initially, signalling that more would come once an adequate level of bank capitalisation had been assessed. Banks would re-open with capital controls initially, with the Bank of Greece providing sufficient liquidity in the transition for ATMs to

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ECB: Business unusual Frederik DUCROZET

frederik.ducrozet@ca-cib.com

No. 15/227 13 July 2015 - 2 -

operate and other financial services to be restored gradually.

Still, a credible commitment to back the banks balance sheets would support such an increase in ELA, which the ECBs Governing Council should deem temporary. Ultimately, if/when a third bailout is in place with such a backstop, the ECB could justify a return to normal refinancing as Greek government-backed collateral would become eligible again.

In other news, the ECB will hold its regular policy meeting on Thursday, and it is unlikely to generate any surprise. Mario Draghi will have little choice but to maintain a dovish tone given the circumstances. Were it not for Greece, the Governing Council would be enjoying the gradual, domestically-driven, QE-boosted recovery in the

Eurozone. Soft data (PMIs) has proved resilient, especially in the periphery where Markit noted the first inflationary pipeline pressures in years as the result of higher input prices and improving labour market conditions. Hard data (industrial orders and output, retail sales) has started to catch up with leading indicators, including in France and Italy. Credit flows are rebounding, borrowing costs continue to fall as a result of ECB actions, which Draghi should stress once again. At the same time, there is no escaping the fact that recent developments will have damaged the credibility of EU institutions. Considerable damage has been done in terms of political capital and overall trust that will need to be restored over time. The ECB should reiterate its willingness to support the Eurozone economy, leaving all easing options open in the spirit of recent comments by Coeur and Praet (see Whatever it takes, version 2.0).

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