Review of ECB Actions and Press Conference

May 7, 2009

  • The refinancing rate was cut by 25 basis points to 1.0%.  This was the seventh cut since October from a peak of 4.25%.  Four of the cuts were by 50 bps, but just one exceeded that size, a 75-bp cut in December.  April’s reduction, like this one, was by 25 basis points.
  • The deposit rate/marginal lending rate corridor surrounding the refinancing rate was reduced from +/- 100 bps to +/- 75 bps by cutting the MLR by 50 bps to 1.50% but leaving the deposit rate at 0.25%.  Trichet called the new central bank rate structure “appropriate” but explicitly did not rule out the chance of future rate reductions.
  • The ECB will launch 12-month refinancing operations in late June.  Like the present 7-day and 3-month tenders, the 12-month operations will be conducted at a fixed rate, starting with the 1.0% refinancing rate but perhaps in the future including a premium.  All bids will be allotted.
  • The Governing Council agreed to buy around EUR 60 billion (equal to $80.6 billion at the present spot rate of $1.346)of covered euro-denominated bonds.  Trichet refused to call such quantitative easing and said details of the program would be announced at the June 4th press conference.
  • Henceforth, the European Investment Bank becomes an eligible counterparty of ECB monetary policy operations.

All decisions were made unanimously.  The ECB has significantly reduced its growth forecasts because first-quarter growth was much weaker than assumed and no recovery is expected until 2010.  CPI inflation will sink below zero for a few months in the middle of this year but is projected to be positive again by yearend.  New quantitative price and growth figures will be unveiled on June 4th as scheduled.  Risks around the forecasts are broadly balanced.  Medium-term inflation expectations are said to still appear “firmly anchored” and consistent with the central bank’s notion of price stability according to the numerous measures studied by the ECB staff.  While there are signs in Euroland and elsewhere of “stabilization” in economic activity, the ECB statement cautions that the labor market will be one of possibly a few key areas that will in fact worsen in coming months, and officials distinguish stabilization from recovery, which is not foreseen starting until 2010 and then only at a gradual rate.

The ECB’s analysis of monetary and credit growth trends corroborates the conclusion of its economic analysis, namely that inflationary pressures are diminishing.  The March on-year growth rates are 5.1% for M3, 3.2% for private credit, and 6.3% for loans to non-financial firms, down respectively from 10.3%, 12.1%, and 15.0% in the year to March 2008.  Several money and credit lines recorded actual month-on-month declines in the latest report.

The ECB still wears fight-inflation glasses.  The bond purchases it is planning are less than 43% of what the Bank of England has announced thus far, and it cut its refinancing rate by just 325 basis points from peak compared to declines of 513 basis points by the Fed and 525 bps by the Bank of England.  Great reliance is placed on estimates of expected inflation, a subjective concept that in truth difficult to measure accurately.  Officials also depend heavily on their forecasts, which have consistently understated the severity of Europe’s recession.  The euro remains outside of the policy spotlight, a stark contrast to the Swiss National Bank where preventing franc appreciation is the top near-term goal or even the Bank of England, which routinely comments about sterling and its impact on policy goals in its minutes.

Lessening risk aversion and less drastic use by the ECB than the Fed or BOE of unconventional monetary stimulus should keep the euro’s tone firm.  $1.40 is more likely to be challenged than $1.20 in the next six months.

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



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