ECB Policy Held Steady

August 6, 2009

No significant surprises emerged from the ECB statement and press conference.  Key interest rates (a 1.0% refinancing rates sandwiched between a 0.25% deposit rate and a 1.75% marginal lending rate) were retained as expected.  A EUR 60 billion program of covered bond purchases was not changed, either, and growth and price developments have not surprised officials, who kept the same basic outlook as before.

The macroeconomic picture depicts the recession persisting in 2H09, albeit at a much slower pace than earlier.  The economy will stabilize early in 2010, and gradual positive growth will ensue as the year unfolds.   Positive CPI inflation is expected to return before the end of 2009, but inflationary pressure will be low throughout 2010.  Measures of expected inflation in the medium term continue to be consistent with the target of below but close to 2%.  Risks to the outlooks for both growth and inflation are deemed to be symmetric.  Accordingly, the current policy stance is considered “appropriate.”  Trichet, as before, emphasized the considerable amount of uncertainty surrounding the forecast.

Rhetoric occupies a central role in ECB policymaking.  In deed, the ECB stance is as loose as others.  Much of the stimulus has been engineered behind the scenes by extremely generous injections of liquidity up to a year via repos.  Overnight euro area and U.S. Libor rates are similar, and each lie below the U.K. level.  The one-month euribor rate is also somewhat lower than one-month euro-sterling.  In contrast, the ECB accentuated positive future trends in growth and prices and left the strong impression that policy will not be loosened any further, whereas the Bank of England candidly said that the British recession had been deeper than expected and that an extension of quantitative easing would be needed in order for inflation to rise back to target within the medium-term time horizon.  The ECB has been called a stealth stimulator that prefers a more hawkish rhetorical tone to keep a lid on price expectations.  The timing of the first interest rate hike remains very uncertain.  Such will undoubtedly not happen before 2010, and if the economy is only going through a phase of stabilization early next year, it’s very doubtful that the refinancing rate will be raised before June. In the last interest rate cycle, the ECB held the refinancing rate at the trough of 2.0% for 2-1/2 years from June 2003 to December 2005, a period that saw ten consecutive quarters of low but positive economic growth.  Officials managed to tighten right before growth up-shifted to a higher gear.  In retrospect, they may have waited too long, and since the rate structure is now considerably lower than then, it will be their hope to raise rates much sooner than after ten quarters this time. That only means that the move is likely to happen before 2012.  No less an authority than former ECB Director and Chief economist Otmar Issing is urging the central bank not to drop its guard against inflation, and  several current ECB members will not want to wait until 2011. 

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



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