No Changes Foreseen From July's ECB Policy Meeting

July 1, 2009

The ECB Governing Council, the 16 presidents of EMU member central banks plus the six directors, holds an off-site policy meeting in Luxembourg tomorrow where “wait and see” will be the order of the day.  It would likely take an unexpected deepening of the regional and global recessions to elicit either a further central bank rate reduction or more aggressive asset purchases.  Although ECB President continues to reiterate that further easing has not been unconditionally ruled out, the message is that present policy is already very accommodative, appropriate and still priming the system, and the need for further loosening is unlikely to arise.  Private analysts find this scenario to be not only credibly plausible but probable.  The central bank’s refinancing rate was lowered in five steps of 50 basis points each in October, November and March, a cut of 75 basis points in December and a final 25-bp reduction to 1.0% three months ago in April.  The ECB deposit rate, which is more akin to the Federal funds target than the refinancing rate, is now just 0.25% and not dropping further under any circumstances. 

A plan by the central bank to buy EUR 60 billion of covered bonds starting in the present month and ending no later than mid-2010 was unveiled in May.  Last but not least, the ECB continues to provide unlimited liquidity to banks at the refinancing rate in widely varying maturities ranging up to 12-months.  The first 1-year tender last Wednesday supplied banks with an eye-catching EUR 442 billion (some $625 billion), nearly doubled outstanding liquidity from this facility, and was largely responsible for a 17-bp reduction in the three-month euribor rate between end-May and end-June.  Dubbed a “stimulus by stealth” in the Financial Times, the ECB’s approach has the advantage over the Fed’s quantitative easing of automatically getting reabsorbed without the central bank having to make explicity decisions to do so.  Of course the ECB, like other central banks, will need to announce rate hikes.  But the 1-year refinancing operations in particular have convinced money markets that such a process isn’t going to begin for several more quarters.  Policy in the near-term is on automatic pilot at a loose and steady setting, allowing ECB officials plenty of time to sit back and monitor whether economic and financial market trends are holding within acceptable limits.

Euroland inflation has dipped into negative territory for the first time in 56 years.  This was predicted by ECB officials, who said the slide under zero would be temporary.  The latest central bank CPI forecast ranges are centered around 0.3% this year and 1.0% in 2010, and risks around those estimates are considered balanced.  A continuing but less severe recession is expected in the second half of 2009, and growth next year is only projected to average minus 0.3%.  Growth risks are also considered symmetric.  The growth perspective seems consistent with economic data, including today’s PMI reading for manufacturing, which remained below 50 but to a lessening extent.  Trichet has repeatedly defended the assertion that inflation expectations remain anchored near the Bank’s definition of medium-term price stability being below but close to 2%.  One possible area of interest at Thursday’s conference could center on that prediction in light of a continuing deceleration of money growth to 3.7% on M3 and 7.9% on M1, private sector credit to 1.8%, mortgage loans to minus 0.5%, and loans to companies of 4.4%.  For now, Trichet can always fall back on the argument that slow money and credit growth now offsets excessively rapid trends for several years earlier and are not alarming in that context, but investors would not find such to be terribly convincing if that’s all he offers.

The other possible area of surprise concerns the euro.  ECB press conference statement steer clear of commenting on the euro’s external value practically without exception.  EUR/USD is now only at the cusp between comfort and discomfort.  However, verbal currency manipulation can be tempting in an environment of extreme economic slack but signs of reawakening demand in export markets.  Canadian and Swiss monetary officials have notably protested appreciations of their currencies with success in arresting those trends.  Trichet might feel the urge to jump in line, but that would not be my baseline forecast.  Currency policy has always been more reactive than pre-emptive, and I think it would take a more alarming climb in the euro for Trichet to address the topic.

The ECB rate announcement arrives Thursday at the usual 11:45 GMT hour, and the press conference kicks off at 12:30 GMT, the same time U.S. labor market figures get released.

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

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