ECB Likely to Cut Interest Rate for a Second Straight Month

December 7, 2011

The stage seems set for a reduced refinancing rate of 1.0%.  The announcement of this second straight 25-basis point rate cut will be made at 12:45 GMT on Thursday and would return such to the cyclical low that prevailed from May 2009 until April of this year.  A press conference to explain the move will follow at 13:30 GMT.  The ECB also seems likely to deepen its use of unconventional measures to facilitate the ability of those who need credit to obtain such.  The ECB’s failure to take such moves would be a vote of no confidence in political leadership in the euro area and would lead to considerable turbulence in financial markets.  It’s possible that markets will react adversely even with the announcement of new monetary support in a  “buy the rumor, sell the fact” reaction.

As always, the ECB will justify such a move by a change in inflation risks.  Even though consumer prices posted on-year gains of 3.0% for a second straight month, shifts in the regional and global economies suggest that price risks in the medium term are even more downwardly skewed that they were a month ago.

Compelling evidence exists to suggest that the euro area has entered a recession.  The ECB’s view that it will be mild is not convincing.  The recession’s origin is financial market dysfunctionality, and those kinds of downturns tend to be severe, as the world learned in 2008-09.  To be sure, Europe experienced a steep drop in production and demand already.  While that slide is the basis for optimism about this second recession’s severity, the 2008-09 event failed to be cathartic.  Had it been so, there would not be massive disequilibria in the region that exists currently.  Also, monetary and fiscal policy had greater room to reflate in 2008 than exists now.  So, current grounds for worry are indeed high and based in fact, not fancy.

Forward-looking economic indicators have deteriorated.  Industrial orders fell 9.6% at an annualized rate in the third quarter and ended that period 3.9% below the 3Q average.  November’s euro area manufacturing purchasing managers index of 46.4 compares to 47.1 in October and an average third-quarter reading of 49.8.  The services PMI reading was 47.5 versus 50.6 on average in 3Q.  The euro area’s economic sentiment index fell from 103.4 at mid-year to 93.7 last month.  Consumer confidence fell 10.7 points over those five months to minus 20.4, while industrial sentiment dropped by a similar 10.8 points to minus 7.3.  The ZEW expectations index worsened 7.9 points to minus 59.1 between October and November.  Retail sale in October were unchanged from the 3Q mean, having shown no growth in that third quarter, either.  Construction output in September slumped 1.3% on month.  Prior to this autumn, real GDP in the euro area had expanded at a stalling speed of less than 1% annualized in both the second and third quarters.  Any fresh stress, and there have been plenty, were primed to send the region back into recession.  The OECD projects that GDP will edge up 0.2% in 2012 as a whole but only if EU leaders resolve their sovereign debt crisis now.  Growth of 1.4% is penciled in for 2013 under that scenario.

In today’s edition, chief economist for the Financial Times Martin Wolf has one of the most insightful articles that I’ve read on the sovereign debt crisis.  The main point, backed by empirical evidence, is that it’s a balance of payments crisis, not a fiscal one.  Debt-to-GDP and deficit-to-GDP ratios prior to 2008 gave little inkling of which countries would now be in the market’s sights, and which others would be considered core Europe and therefore safe.  However, a close correlation does exist between today’s have nations and have-nots and whether they run chronic current account surpluses or deficits.  The solution that EU leaders appear to be fashioning does not address the question of reducing external account imbalances, and the emphasis of the solution on fiscal austerity threatens to aggravate, not alleviate, the basic source of the whole problem.  Rahm Emmanuel famously articulated that “you never want a serious crisis to go to waste.”  Fiscal deficit hawks on both sides of the Atlantic have successfully taken advantage of cyclically bloated government deficits to promote political agendas that are in fact a distraction from the main problems afflicting advanced economies, namely insufficient aggregate demand.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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