ECB Eases and Slashes Growth and Price Projections

March 5, 2009

The European Central Bank cut its rate structure by 50 basis points to new historic lows as anticipated.  While the rate most widely watched by market participants becomes 1.5%, further from zero than the main U.S., British, or Canadian rates, the new deposit rate of 0.5% does move to a similar neighborhood where additional reductions could damage money market functionality.  The marginal lending rate also was cut by 50 basis points to 2.50%. Today’s cuts were the fifth since October 8th and lifts cumulative easing since then to 275 basis points.  These actions were decided by “consensus,” meaning not unanimously.

The most important sentence of the ECB statement released today reads, “signs of a more broad-based reduction in inflationary risks are also increasingly emerging.”  Until now, officials had conceded the possibility of a dip in on-year inflation below zero around mid-2009 but acceleration thereafter and a relatively quick return to target of readings “below but close to 2%.”  New CPI forecasts revised the upper range limit for 2009 down a full percentage point to +0.7% and the upper range limit in 2010 down 0.7 of a percentage point to 1.4%, which also remains below the ECB definition of price stability.  Fortunately, measures of expected inflation over the medium term signal that such remain “well anchored.”  However, after ECB President Trichet reiterated this sign of continuing faith in a return to price stability in the medium term, he added, “knock on wood.”  The point is that if inflation were to remain far below 2% for too long, expectations would be prone to adjust downward to the new reality.  The danger of upwardly creeping expected inflation when actual inflation had surpassed 2% was in the past repeatedly cited as justification for tighter monetary policy.  The same logic ought to hold on the downside. So Trichet can report that inflation expectations haven’t moved so far, but he is crossing his fingers in hopes that such does not happen in the future.

The evolution of ECB forecasts for real GDP growth and CPI inflation are shown below.  The ECB staff revises their forecasts on a quarterly basis.

  03/09 12/08 09/08 06/08 03/08 12/07
GDP ’08   0.8-1.2% 1.1-1.7% 1.5-2.1% 1.3-2.1% 1.5-2.5%
GDP ’09 -3.2/-2.2% -1.0-0.0% 0.6-0.8% 1.0-2.0% 1.3-2.3% 1.6-2.6%
GDP ’10 -0.7/+0.7% 0.5-1.0%        
CPI ’08   3.2-3.4% 3.4-4.6% 3.2-3.6% 2.6-3.2% 2.0-3.0%
CPI ’09 0.1-0.7% 1.1-1.7% 2.3-2.9% 1.8-3.0% 1.5-2.7% 1.2-2.4%
CPI ’10 0.6-1.4% 1.5-2.1%        


Projected inflation was revised to sub-target corridors for both this year and 2010 because of a much gloomier prognosis for economic growth.  Some of this adjustment was mandated by the negative growth overhang following a 6.2% annualized plunge of GDP in the fourth quarter of 2008.  But in fact, officials cite recent hard data and survey evidence to assert that global and Euroland demand will continue to weaken sharply and recover only gradually in 2010.  Risk around the new growth forecasts, which are centered on -2.7% this year and zero in 2010, is considered less biased to the downside than before as a result of greater-than-imagined fiscal and monetary stimulus, plus measures to alleviate credit market strains.  Nonetheless, rising protectionism, the possibility that financial turmoil doesn’t abate as soon as assumed, and the potential for a disorderly correction of global imbalances make it possible that growth will turn out even worse than the new forecasts.

The ECB’s analysis of monetary and credit growth confirmed further “that inflationary pressure has been diminishing.”  Officials had nothing significant to say about the euro, which has declined 8.3% against the dollar since the first rate cut on October 8th but risen 2.2% on a trade-weighted basis in the same period.  Trichet did underscore the view that rules for joining the common currency union mustn’t be watered down for Eastern European governments aspiring to become members.  The possibility of a debt default by one of Euroland’s existing members or the need to bailout an East European economy against whom Western European banks are extremely exposed are two factors weighing heavily on confidence in the euro.   Finally, in Q&A the Bank President also underscored that ECB officials face different circumstances than other central bankers as they contemplate full quantitative easing, which is a reference to the lack of a unified fiscal policy authority for the group.  The ECB gets unfairly criticized by market participants for appearing to plod excessively.  Part of the reason for the Bank’s more conservative behavior relates to the unique circumstances of a currency union shared by many nations.

The ECB is not ready to engage in quantitative easing as blatantly as the Fed or Bank of England but has taken some steps that are not exactly standard, and Trichet underscored that no actions are being ruled out.  Future policy will be dictated by future market and data trends.

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



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