ECB Preview

February 8, 2012

The ECB interest rate announcement will be made Thursday at 12:45 GMT and be followed at 13:30 GMT by President Draghi’s fourth press conference.  Draghi has received good reviews for his communication and leadership skills at these monthly occurrences.  The ECB refinancing rate was cut by 25 basis points each in November and December but left at 1.0% last month.  Analysts are split over whether the refinancing rate is likely to be cut a third time this month.  It’s hard to imagine that a cut would endanger the anchoring of medium-term expected inflation, and economic growth risks continue to be biased to the downside around a baseline forecast that concedes a near-term recession that began last quarter when GDP likely fell about 2% at an annualized rate (saar) versus 3Q.  GDP only climbed 0.6% in the prior summer quarter.  Most forecasters are now projecting sub-zero GDP growth in 2012 as a whole.  A World Bank projection of 1.1% growth next year is representative.

Inflation has crested.  According to ECB forecasts, CPI inflation, which is currently 2.7%, will remain above target for several more months but then trend lower and reach the target of "below but close to 2%" eventually.  The euro hasn’t collapsed in spite of the debt problems faced by many members.  Greece and Portugal, the main concerns of everybody, saw their 10-year interest rate premiums widen since the January ECB meeting, but the premiums of Italy and Ireland fell by over a percentage point.  Spain’s premium is also narrower now than then. 

As in the case of the Bank of England meeting also tomorrow, some analysts are wondering if much better-than-expected purchasing manager survey results in January might dissuade ECB policymakers from cutting the refinancing rate to 0.75%.  The manufacturing PMI score of 48.8 was 1.9 points higher than the 4Q average reading.  The services PMI was higher than 50, implying a mild rate of expansion, and was 2.8 points better than the 4Q mean at 50.4.  The composite reading was also 50.4 and 3.1 points above its 4Q average.

Other data remain worrisome.  Business sentiment only improved 0.6 points to a still depressed reading of 93.4.  Consumer confidence (minus 20.7) is very weak, and retail sales posted back to back 0.4% drops in November and December, falling in 4Q at a 2.6% annualized rate from 3Q. Euroland has a 10.4% jobless rate, 2.1 percentage points higher than U.S. unemployment.  The forward-looking index of industrial orders was 4% lower in October-November than in 3Q.  In Germany, industrial production and merchandise exports fell in December by 2.9% and 4.3% from November.  Construction output in the euro area was 2.0% lower in October-November than in 3Q. 

It’s become more apparent since the January meeting that the ECB’s unlimited 3-year refinancing operation in December was more stimulative than realized initially, and such is increasingly being viewed as a creatively unorthodox form of quantitative easing, even as ECB officials continue to reject doing straight asset purchases like the Fed and Bank of England have done in considerable volume.  Another LTRO operation by Euroland’s central bank is planned for later this month.  Much of tomorrow’s press conference will try to clarify the purpose and effect of these measures.  The ECB’s attitude regarding fiscal consolidation will also be raised in numerous questions. If a credible fiscal plan can be hammered out and given the ECB views that the economy is in recession and inflation will be returning to target, the prudent thing to do is to support economic growth as far as is safely possible.  To reject a third rate cut now could produce one of two effects: panic Greek bailout negotiators into delaying no further or create general despondency by all that a strategy that meets economic weakness with more fiscal austerity but no monetary offset is a plan that will probably fail.

It’s up to the ECB to roll the dice, and since the decision is made by a committee of 23 with each holding one vote, handicapping tomorrow’s verdict is also a roll of the dice.  I believe the right thing to do would be to implement a third cut.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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