ECB Press Conference More Dovish Than Formal Statement

December 4, 2008

The ECB rate cut of 75 basis points was larger than any taken before and exceeded the 50-bp amount suggested in remarks by officials during the past month. But in line with recent horrific data and the huge rate cuts of other central banks this week, 75 basis points is at the low end of what could reasonably have been expected today and might disappoint many market participants. Fact is, it’s very hard to justify why the refinancing rate of 2.5% now should be higher than the 2.0% level that prevailed for 18 months to December 2005. The expression “behind the curve” still comes to mind.

A formal introductory statement from ECB President Trichet notes worsening survey data in October and November without going into detail just how frighteningly weak such are or to note corroborating evidence from hard data like industrial production, retail sales, and two-way trade flows. Price risks are “called more balanced than in the past.” The statement sees downside risks around mid-2009 but dismisses the pertinence of such because they would be due to special factors like lower commodity prices and negative base effects. Upside subsequent price risks are then mentioned. While other central banks warn of deflation, the ECB policymakers representing 15 countries cannot bring themselves to state flatly that price risks might be skewed even a little on balance to the downside. ECB officials failed to concede greater downside price risk even though their monetary analysis no longer supports a view that medium-term risks lie to the upside.  The statement also preaches the virtue of anchored price expectations as the best contribution monetary policy can make to laying a basis for an eventual, albeit gradual, recovery from recession. While other governments are rushing out big fiscal stimulus packages, the ECB statement commands politicians to respect EU rules including limits for deficit spending inscribed in the Stability and Growth Pact. Where maneuvering fiscal room exists, governments are admonished to take only steps that “are timely, targeted, and temporary.”

The ECB also urges pay negotiators to act responsibly. For some time, the central bank has railed against wage indexation. Former U.S. President Reagan produced a watershed in the declining influence of organized labor when he stood up to air traffic controllers, PATCO, in 1981 and caused the union to blink. The ECB wants to be an agent of similar change in Europe, and that is the hidden agenda behind its perennial bias toward monetary restraint.

The ECB released new price and growth forecasts, as it does each March, June, September and December. GDP is projected to contract between 1.0% and zero percent next year. That’s weaker than forecast ranges of +0.6 – 0.8% made three months ago and 1.6 – 2.6% made in December 2007. But a mid-point of minus 0.5% is actually more optimistic than the consensus of private analysts. The forecast growth rate in 2010 of 0.5 – 1.0% conveys a very fragile exit from recession and implies real economic growth over the three years from 2008 to 2010 of only 0.4% per annum. The consumer price inflation forecast for 2009 is a range of 1.1 – 1.7%, about a half-percentage point below target and down very sharply from a forecast 2.3 – 2.9% issued in September and even less than what officials were predicting a year ago. The CPI is projected at 1.5 – 2.1% in 2010, having the same mid-point as the 1.2 – 2.4% forecast for 2009 issued in December 2007. It is little more than a statement that medium-term inflation will be exactly on target, and that is a subtle way of defending the assertion that current rate levels are “appropriate.” If forecast medium-term inflation were not at their target, how could officials say rates are appropriate?

In the question and answer part of the press conference, which was held at the off-site of Brussels, not in Frankfurt, Trichet struck a more dovish tone than his remarks. He stressed that price risks had diminished very sharply within a brief period of time and did not flatly rule out the possibility of quantitative easing in the future. He said there was a consensus in favor of the 75-bp rate cut now but would not deny that a bigger move might have been discussed. He also picked up on a theme of several central banks that a better job needs to be done to ensure that central bank rate reductions get more fully passed onto lending rates offered to households and businesses. And he said nothing to suggest that rates are probably as low as they need to go in this cycle.

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