No time for a pause – ECB January 2009 Preview

“Yes, the ECB will cut interest rates at its January 15 meeting”. “Whether it will be a 25 or a 50bp ease remains a very close call. We stick to our 25bp forecast – introduced at a time when several Council members including Trichet were hinting at a pause – but acknowledge that a bolder move may well be in the cards and probably more useful”.

ECB – A welcome 75bp cut. Communication remains an issue

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.

A significant GDP contraction in 2009

October 2008 represented the high point of the ongoing financial crisis. In Trichet’s words after the Lehman collapse, we entered a new era and financial strains have become almost unbearable. The toll on economic activity will be huge and, as we have been arguing for a while, the banking system is at the center of the crisis. Lending standards have been tightened significantly in response to deleveraging efforts, increasingly expensive bank capital, and almost-frozen access to wholesale funding. At face value, lending to firms continues to grow at a nice pace, but the combined effect of plunging financial equities, skyrocketing real corporate bond yields and qualitative evidence from the ECB Bank Lending Survey will result in a sizeable reduction in the credit flow to the economy. Fiscal policy measures aimed at preventing the seizure of the credit channel will help, but a credit rationing can hardly be avoided. Fixed investment will be severely impacted and, concurrently, the global economy is deteriorating fast, with emerging countries –Eastern Europe in particular – joining the widespread slowdown. As a consequence, we are revising down our 2009 GDP forecast to -0.7% from the prior +0.3%. Below, we provide arguments for our change of call.

ECB on the eve of an aggressive easing

– The eurozone growth outlook continues to deteriorate. The economy may have avoided a technical recession in Q3, but a negative GDP reading in Q4 seems very likely. The recovery in the course of 2009 will be only tentative.

– Concurrently, CPI perspectives have brightened considerably: thanks to plunging energy prices, headline inflation will probably fall very close to 1% next summer and below 2% on average in 2009.

– The ECB has room to cut rates aggressively. We expect two 50bp cuts before the end of the year, and the Refi rate down to 2% by mid-2009.

ECB and BOE: From reality check to nightmare

For European central banks, the reality check of weakening growth is quickly turning into a nightmare called recession. October PMIs showed eurozone business confidence is disintegrating, while UK GDP shrank by 0.5% in Q3. The ECB and the BOE have been badly wrongfooted by the sudden joint collapse in both the real economy and the financial sector. This is worrisome and embarrassing for two central banks that appeared exceedingly sanguine in the earlier stages of the credit crisis—particularly the ECB, which hiked interest rates as recently as three months ago.

The “R” word is no longer taboo

We have been pessimistic on the eurozone growth outlook for quite some time, but the intensity of the economic slowdown during the summer has surpassed our expectations. Q2 GDP dipped into negative territory and, probably more worrying, business surveys have continued deteriorating so far in the third quarter, suggesting that underlying growth momentum is now […]

Preliminary thoughts on ECB press conference

Certainly this was not a boring ECB press conference, although the market reaction was relatively muted. After a bit of intra-meeting volatility, binds where they were at the start of the presser. In our view, most interesting things on the monetary policy front were: 1. Apparently the first numbers on 2009 GDP projections that circulated […]

Eurozone GDP/inflation mix turns dovish

For the first time since the inception of the common currency area, eurozone GDP contracted by 0.2% q-o-q in the second quarter of 2008. The country breakdown has been slightly surprising with Germany faring a bit better than feared (-0.5% q-o-q), and France and Italy both contracting by 0.3%. France is the real negative surprise […]