ECB Preview

April 1, 2009

Markets are priced for a 50-basis point cut of the ECB refinancing rate to 1.0% at 11:45 GMT on Thursday, and central bank officials have said nothing to dissuade those expectations.  By itself, that creates a compelling case for such action by this transparency-minding body of monetary officials.  The ECB utilizes three interest rates, a marginal lending rate, the main refinancing rate, and a deposit rate.  Presently, the marginal lending rate is 100 basis points higher than the refi rate, and the deposit rate of 0.5% lies 100 basis points below.  From October 9, 2008 to January 21, 2009, the corridor around the central rate was 100 basis points, not the more normal 200 bps, in width.  If the deposit rate were to be lower in tandem with the refinancing rate, it would go to zero, moving the ECB into the ZIRP (zero interest rates) club, which officials have wanted to avoid.  A way around that technicality would be to leave the deposit rate at 0.5% and to cut the marginal lending rate by 50 basis points to 1.5%.

New OECD forecasts released yesterday project Euroland GDP declines of 4.1% this year and 0.3% in 2010.  On-year CPI inflation has already dropped to 0.6% and appears below the path that ECB officials had been assuming.  Moreover, plunging growth implies a widening output gap and intensifying downward price pressures, making the ECB’s projected CPI range for next year of 0.6-1.4% appear too high and dependent on a significant upturn in world commodity prices.  Even for a central bank with the single mandate of securing medium-term CPI inflation below but close to 2%, a call to action is mounting to prevent deflation.  That is why a closer endorsement of quantitative easing, not just providing unlimited liquidity, is a step that seems unavoidable.  The purchase of government securities, as the BOJ, Bank of England, and Fed are doing, is not easily transferable to the ECB, however, since there are sixteen governments involved.  President Trichet may shed light on how the central bank might handle these technicalities.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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