In a bolder manner than the stance adopted so far, the ECB cut the refi rate by 75bp – the biggest cut in their history – bringing it to 2.50%. Based upon their recent rhetoric, only aimed at justifying their steady-hand approach adopted up to today, we were expecting another 50bp cut. We certainly praise the move, but there is again in our view a clear problem of consistency between words and action. The decision has been taken by consensus and was not unanimous, meaning that the hawks would have preferred a 50bp cut. Trichet also said that he didn’t have a previous view on today’s cut, which frankly is hardly believable and difficult to square with recent statements (remember Bini-Smaghi and the cavalry in the spaghetti-western?). This tells of a Council not yet fully aware of how serious and bad is the recession hitting the euro area.
In a nutshell, key features of today’s press conference were:
- The statement does not contain the word “recession”. It talks about a significantly dampened aggregate demand, global crisis spreading around, but there is no willingness to put the accent on the depth of the downturn.
- Risks on inflation are now more balanced than in the recent past, although some upside risks still persist. Plus, the ECB is putting a strong emphasis on the fact that the decline in inflation has to be ascribed mainly to the fall in commodity prices, and not (yet) to the underlying slowdown. Moreover, Trichet affirmed a clear distinction between dis-inflation and deflation, the former not excluding the possibility that y-o-y CPI will dip temporarily in negative territory. While it’s undeniable that strong declines in commodity prices and favorable base effects will play the lion’s share in dampening prices pressures until next summer, we strongly believe that core pressures are headed for a significant slowdown bound to last throughout the forecasting horizon.
- In our view this assessment is not completely consistent with the staff projections that see inflation meeting the ECB’s definition for price stability for the foreseeable future (with an oil assumption of $67 in 2009 and $76 in 2010). Plus the inflation outlook has to imply a slowdown in unit labor costs and the ECB no longer talks about second-round effects in the first paragraph of the statement.
- Staff projections were almost exactly as we were expecting. Inflation midpoints were 1.4% and 1.8% for 2009 and 2010, respectively. Growth is seen averaging -0.5% in 2009 and 1.0% in the following year. The GDP numbers are too optimistic in our view. Next year growth will plunge in the -1% neighborhood and although we see growth accelerating in 2010, risks that the recovery will be only tentative are more than concrete.
Clearly, after today’s press conference we are left with the feeling that with recent rhetoric and the persistent reluctance to acknowledge how serious the macro situation, the ECB has cornered itself and it is now fighting to regain credibility. These days, it may be too risky to remove easing from market expectations because the reaction will be harmful. Our take is that the ECB is progressively – though slowly – understanding the dramatic pace at which the crisis is spreading across the area. They can only continue to cut rates and bring them to lows never seen in the euro history. We were thinking at 2% as the trough, but it is clear that it will be crossed south. By mid-next year, the refi rate may well be at 1%. We don’t think such a target would be in contrast with Trichet’s statement “beware of being trapped with rates too low”, probably referred to a zero-rate policy.