ECB happy to stay put after Brexit vote as markets regain pose: sources

[June 29, 2016]  By Francesco Canepa and Balazs Koranyi

FRANKFURT (Reuters) - The European Central Bank is in no rush to ease its monetary policy in response Britain's vote to leave the European Union, taking comfort in a calmer-than-feared market reaction, several sources have told Reuters.

The Brexit vote has hit the shares of euro zone banks and is likely to act as a drag on the euro zone economy, as ECB President Mario Draghi told EU leaders on Tuesday. It is also raising fundamental questions about the future of the EU.

But conversations with around a dozen officials familiar with the ECB's thinking showed that the bank found some reassurance in the market rebound this week and was happy to take a wait-and-see stance, given the lack of hard evidence about the actual impact of Brexit.

Emergency swap lines designed to provide euros to UK banks in case of stress had not been activated and, contrary to what had happened during the 2008 crash, financial markets had functioned smoothly despite heavy losses in the pound and some shares, the sources, who asked not to be named, said.

They stressed the ECB's willingness to provide more stimulus if the inflation outlook worsens but cautioned the UK vote was raising political questions that were for EU governments and institutions, rather than the central bank, to answer.

"This is a political problem not a monetary phenomenon," one of the sources said. "We could act, we have the tools, but that would not solve the broader problem and for now, every estimate about the actual impact of Brexit is nothing but guesswork."

The officials added it was too early to assess the impact of the referendum on investor and consumer confidence - the most immediate transmission channel - and the bank would be in a better position to make a call on that when it gets updated staff forecasts in September.

If markets continued in the same, calm vein in the run up to the ECB's July 21 policy meeting, the most to expect could be verbal reassurance that the bank stands ready to do more if needed, conversations with the sources showed.

For now, the officials expressed relief at the sanguine reaction of investors in sovereign debt. Southern Europe's borrowing costs fell sharply for a third straight day and French bond yields hit record lows on Wednesday. [GVD/EUR]

The calm on the sovereign bond market marked a sharp contrast to the 2010-12 debt crisis, when a 'doom loop' between indebted governments and their main creditors, banks, threatened the euro's very existence, the sources noted.

"Markets priced in a lower growth path, both for the euro zone and the UK," one source said. "It seems quite realistic now and I don't see significant overreaction."

Still, this line of thinking may put the ECB on a collision course with markets, which have rebounded at least partly in the hope that the ECB and the Bank of England would step in with more stimulus.

European Central Bank (ECB) sign is pictured outside its headquarters in Frankfurt, Germany, April 21, 2016. REUTERS/Ralph Orlowski

Investors now fully price in a rate cut in Britain and the euro zone by the end of this year.

The ECB cut rates twice since December and is already buying 80 billion euros ($88.71 billion) worth of assets, mainly euro zone government bonds, every month in a bid to boost inflation.

These purchases helped soothe market nerves when a Greek referendum on the terms of its bailout agreement with creditors almost pushed the country out of the euro zone last summer and the reaction to the UK vote was seemingly following the same path.

The sources said that any further move by the ECB to support markets, while possible in theory, would merely act as stop-gap and do nothing to address fundamental citizen and investor concern about Europe's political cohesion and economic strategy.

BANKS

In fact, a new interest rate cut could even exacerbate problems at euro zone banks, which have complained that low lending rates and a charge on the money they park at the ECB were squeezing their margins, some of the sources said.

There was agreement among the officials who spoke to Reuters that the broad selloff in banking shares cast the sector as the weakest link in the European economy, with its meager profits and, in countries such as Italy, heavy burden of bad loans making it vulnerable to any economic downturn.

The ECB's top supervisor, Daniele Nouy, spelled out some of the steps the ECB would like European and national law-makers to take in a letter to a group of members of the European parliament published on Tuesday.

"Among other reforms, they should consider streamlining legal processes related to debt recovery, removing impediments to the enforcement of loan collateral, introducing out-of-court debt work-out solutions, and fostering the development of distressed debt markets," Nouy wrote.

($1 = 0.9018 euros)

(Editing by Jeremy Gaunt)

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