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The first rate decision of the ECB for 2012 will likely not consist of any new unconventional measures nor rate cuts. This comes as the chances of a Greek default are rising, together with distrust among banks.

Will Draghi surprise with a bigger move? Probably not, and this may be painful for the single currency. ECB Preview. Follow the press conference at the live blog.

The president of the ECB, Mario Draghi, is in office for only two months, but he was very busy. Each decision consisted of a rate cut. These cuts reversed the actions of his predecessor Trichet. In the last meeting, a bigger unconventional measure was introduced: 3 year unlimited loans to banks, known as LTRO.

Help for Banks

The first LTRO operation was huge: €489 billion were lent to banks. This probably prevented a “Lehman moment” – no credit crunch was seen. At least not yet. Unfortunately, the operation didn’t manage to lower the high yields on Italian bonds.

Italy still suffers from high yields (7% on 10 year notes) which make its debt unsustainable. The LTRO operation could also have helped this cause: banks pledged bonds as collateral for getting ECB cash; the ECB accepts low grade collateral, and this could have been Italian bonds.

The potential arbitrage for banks didn’t morph into lower yields.  A second operation is scheduled for the end of February. There’s a small chance that Draghi will bring this move forward.

Another option is announcing more operations, for longer terms, although the probability is low.

Interest Rate Decision (12:45 GMT)

As an Italian, Draghi has been bold enough in the German-leaning ECB regarding rates. He oversaw two rate cuts while inflation stood on 3%. It now slid to 2.8% (according to the initial report), but this is still above the 2% (or below) target. Trichet wouldn’t have cut the rates twice.

In addition, the current 1% level for the Minimum Bid Rate is the lowest ever. Some ECB members suggested cutting the rates further, but Draghi is likely to refrain from this action for now. Making a third consecutive cut to new historic levels, would anger some members.

Update:  Draghi indeed left the rate unchanged at 1%

Press Conference (13:30 GMT)

Apart from discussing the LTRO operations, Draghi will probably try to convey a message of “Business as Usual”. This will fit with no decisions. It is hard task in the current environment. The IMF has low trust in Greece’s ability to avoid a default.

The chances of achieving a 50% “voluntary” haircut deal between Greece and the banks diminishes every day. As time passes by, 50% isn’t enough. A second bailout program seems wishful thinking.

In addition, trust between banks remains low. Instead of lending to each other, they extensively use the ECB for loans and for parking cash. The system continues functioning, but this is an abnormal behavior that will likely trigger questions from reporters.

In addition, Draghi will likely be asked about buying bonds in a more extensive manner, after the LTRO didn’t succeed in that case.  There are some reports that Draghi is ready to push forward with QE, despite German opposition.

Euro reaction

Up to now, the ECB is buying only limited amounts of bonds every week.  There is a very slim chance that he will provide some hint about this.

If so, the euro might rise in the short term, but fall afterwards, as significant bond buying will amount to money printing, devaluing the currency.

Any new LTRO operation can also provide some hope, with a limited positive effect on the euro.

There is a much higher chance that Draghi will not announce any new big measures and this will disappoint the markets in the current environment, despite the high expectations for the ECB not to act.

In such a case, of no news, the euro will likely take a hit. The single currency managed to stabilize quite nicely after the sharp falls, and allowed for some consolidation.

Is it ready for new falls? We’ll know soon enough.

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