ECB Preview

May 5, 2009

Thursday’s policy meeting at the European Central Bank will arguably be its most important since the common currency was founded in 1999.  In spite of the talk of “green shoots” in the global economy, an imperative exists to extend monetary easing.  A spectrum of voiced opinions from a minority of the ECB Governing Council members points to a faction-ridden board.  The most likely size of the refinancing rate cut at this time is 25 basis points to 1.0%, since some policy-makers still oppose cutting it to a lower level than 1.0%.  The deposit rate is already at 0.25% and thus will not be reduced, and the marginal lending rate of 2.25% is likely to be sliced by 50 basis points to 1.75%, producing a symmetrical corridor of overnight money rates around the 1.0% refinancing rate level.

The economic situation warrants unconventional easing sooner rather than later.  A wait-and-see approach will not do.  The manufacturing PMI in April was higher than the first-quarter average level of 33.8 but not by much.  A reading of 36.8 reflects a very depressed economy.  Industrial production in January-February was 6.3% below the 4Q level, thus on a pace to match or even be worse than the 22.5% annualized drop in 4Q08.  The same is true for industrial orders, which tumbled over 50% saar in the final quarter of 2008.  Seasonally adjusted exports fell 46% at an annualized rate in the five months between September and February, and retail sales volume in February was 4% lower than a year earlier.  Construction sagged last quarter, and unemployment rose to 8.9% from 8.2% at end-2008, 7.7% last September and 7.2% in March 2008.  As in the United States, economic growth in 1Q09 could match the abysmal drop of 6.2% saar in 4Q08.  This implies a rapidly widening output gap and greater future disinflation than ECB officials had assumed.  Price data add to this picture.  Producer prices tumbled 12.2% saar in the first quarter of 2009, and on-year CPI inflation was 0.6% in March-April, half the January-February pace.  Lending to private non-financial corporations actually fell on a monthly basis in March.

ECB President Trichet has promised to unveil a roadmap of unconventional monetary easing at Thursday’s meeting.  A promise and clarification of such actions in the future, as the Bank of Canada has done, would limit incremental easing to 25 basis points for a second straight month and would be inadequate for what is needed.  The likeliest form of quantitative easing appears to be a program to purchase corporate bonds, but other actions may be included, too.  As the ECB moves into uncharted territory, market reactions will be just as important as the content of whatever new actions officials announce.

The ECB announcement will be made at 11:45 GMT, and a press conference will start at 12:30 GMT on Thursday.

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

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