ECB Preview

August 5, 2009

At Thursday’s press conference, I expect ECB President Trichet on behalf of that bank’s governing council to

  • Make no changes in the key interest rate structure of 1.0% refinancing rate, 0.25% deposit rate, and 1.75% marginal lending rate.
  • Call the present policy stance “appropriate.”
  • Announce no expansion of the covered bond purchase plan.
  • Say that growth and price developments remain mostly consistent with the council’s prior thinking.
  • Call inflation contained but deny the risk of chronic deflation taking root.
  • Suggest that further rate cuts are very unlikely but not to absolutely rule that out.
  • Avoid getting pinned down in quantifying the timing of an eventual interest rate increase.
  • Reassure his audience about the will and means to reverse the very accommodative policy so that price stability is preserved in the medium term.
  • Make no protest against recent currency market developments.

Only 13 months have passed since the last ECB rate hike.  The comparable interval since the last hike in U.S. and British central bank rates has been 38 months and 25 months.  The first ECB rate cut was a 50-bp move last October 8, when the ECB joined several other central banks led by the Fed in a coordinated round of easing.  That reduction was followed by cuts of 50 bps in November, 75 bps in December, 50 bps in January and again in March, and two final moves of 25 bps each in April and May.  The ECB doesn’t have to make the first tightening move, especially since there are a number of ways to discard stimulus merely by doing nothing and letting transactions expire.  One wild card will be the future behavior of commodity prices, which are largely responsible for the current 0.6% on-year drop of consumer prices.

Market bets on when ECB tightening will begin have swung widely.  Two months ago, the thinking was it would begin by March 2010.  A month ago, the talk centered around a later date next year.  ECB officials don’t have to hurry assuming they can verbally spin what they are doing in such a way that expected inflation stays contained near the medium-term target.  Euroland GDP fell 4.8% in the year to 1Q09, and the region is likely to report a larger second-quarter contraction than the United States just did.  Even with a marked slowdown in investment which depresses the conceivable rate of economic growth under conditions where all labor and capital could be productively utilized, it would not be inflationary if the level of actual GDP experienced higher-than-trend growth for awhile.  Besides, the economy is still contracting.  The service-sector PMI in July of 45.7 remains far enough below 50 to cast doubt on when positive growth will commence and whether it will be sustained after the boosts from inventory building and fiscal stimulus wear off.  Considerable bad news ahead on the labor market front will exert a continuing drag on consumer spending.  Retail sales volume fell 1.4% at an annualized rate last quarter and dipped unexpectedly in June by 0.2% when analysts were predicting a 0.3% uptick.  Germany has been a leader in the recent improvement of activity according to PMI surveys but has an Achilles Heel in the form of a banking system whose balance sheet is deficient relative to its exposure to potentially bad loans.  A worldwide severe correction downward in equities is not far-fetched if the business cycle turnaround is not V-shaped and would unhinge Euroland’s recovery hopes.

The ECB is in a wait and see mode now, and that’s the prudent course it should take at least for the balance of 2009.

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



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