See rate cut by ECB; may buy Spain, Italy debt: StanChart

After the disappointing Jackson Hole conference, global markets are now focused on the European Central Bank (ECB) on September 6. This meeting would be crucial in deciding if the global risk on rally would sustain.

Gerard Lyons of Standard Chartered told CNBC-TV18 that though global markets are not expecting a rate cut, but there is a possibility of the ECB doing it. In addition to that, a bond buying program may also be announced, he said.  "The ECB has made clear that low interest rates are not having their full impact in terms of helping the European economy because the transmission mechanism of monetary policy has not been helped by the high level of bond yields. So, ECB will buy the debt of likes of Spain and Italy," he added. Below is the edited transcript of Lyons’ interview with CNBC-TV18. Q: What are your expectations from Mario Draghi on Thursday? A: A combination of factors will happen at the forthcoming ECB meeting. The ECB could cut interest rates. The markets are not expecting a rate cut. But in additional to that, the ECB will announce some bond buying. Clearly there are tensions across Europe. Not everyone in terms of the policy making environment is in favour of ECB buying bonds. But, the ECB has made clear that low interest rates are not having their full impact in terms of helping the European economy because the transmission mechanism of monetary policy has not been helped by the high level of bond yields. So, ECB will buy the debt of likes of Spain and Italy. Q: The next important meeting which follows is the German court voting on whether they want to participate in ESM or not, how high are the chances that the Germans block that and that spooks global markets? A: In terms of monetary policy environment, they will have to go to the vote. Then it is the case of making sure that those countries that are opposed to the policy, say the Germans, the Fins, the Dutch, we do not see any further fall out in terms of people resigning. But, there is no doubt that the European situation is very difficult. In many respects you have to have some sympathy for these central bankers because monetary policy has become the shock absorber in Europe. Over the last year and a half, it has been the politicians in Europe, in some respects like India, who should have done a lot more. They haven't. They have been slow. When they have acted, they have been behind the curve and have not done enough. Europe has had a self feeding downward spiral where political problems have fed the economic problems have fed the banking problems have fed the financial problems. The central banks have had to combine together to act as a shock absorber. Unfortunately, depending on your position, the central banks have had to act as a shock absorber again this time around. _PAGEBREAK_ Q: You started by saying that you expect the ECB to buy some bonds as early as this week, you then see the ECB going ahead with just Angela Merkel tasset support, not waiting for any kind of official or formal German support? A: It is difficult to really say. We have had events like this before in Germany. What has tended to happen is similar to what has happened elsewhere in Europe. The problem or the issue is put back, so it is quite possible that the constitutional court will not come out with an immediate answer. But it is always possible; there is a risk that it would be an adverse decision. Indeed over the next couple of months, markets are worried as to what could possibly go wrong in Europe. There are many possible candidates for what could go wrong in Europe. Whether it is the constitutional court, much more likely further problems increase with the Trioca, not necessarily agreeing to give the go ahead for further help to Greece. So as a result Europe still remains on high risk alert. The only thing that is preventing things from getting worse is the actions of the central bank. Q: How do you see global market positioning right now, do you think given the risk that you have highlighted, global markets could easily switch on to risk-off mode after the European meetings or do you think global risk might extend itself through September after these outcomes? A: Anything is possible depending on the scenario you construct for Europe. One key message is that against the backdrop of low rates in Europe, UK and the US, and against the backdrop where emerging economies have room for policy maneuver, there is ample global liquidity and hat liquidity is looking for home. Just as we saw markets getting carried away at the beginning of this year, when the markets were hoping that recovery was going to gain traction, there is a lot of liquidity looking for home now and that is underlying, underpinning shall we say, many of the global markets at the moment. Q: What about the US Fed, do you think in the Fed meeting on September, you will get more concrete news on QE3 or just more talk or assurance that it will come when it has to? A: It is more the case of keeping the promise. The message from Bernanke, even though has disappointed some in the markets was very consistent with the recent messages from the FOMC. In the next meeting, if the data is incredibly weak beforehand, then the Fed will engage in QE3. But if the forthcoming data is not that weak, or indeed is just sufficient to suggest that the US economy is growing still at around 2%, then the Fed will not do QE3, but will retain a bias to use QE3 if and when it becomes necessary.