So what is it? A new Tarp? Rumours of large programme buying across Europe? Or are stock markets back to their old habit of betting on a rate cut? In London, the FTSE 100 has been as high as 4855; pre-open the futures market pointed to a level of 4600. Something’s going on.
From Michael Saunders at Citigroup on Tuesday:
Facing a sharp reaction of financial markets after the rejection of the US rescue package by the House of Representatives yesterday and a further bailout of a Belgium/ French bank overnight, there is a decent chance that European Central Banks (ECB, BoE, SNB, Riksbank and the Danish Central Bank) will make emergency easing soon, perhaps this week, especially if the US Fed is also ready to cut again.
Central banks may well try other measures first, such as liquidity injections. The Irish government has announced it will guarantee deposits and some senior bonds of Irish banks. Other measures may also be forthcoming. However, if financial market conditions do not improve soon, then early easing also will be on the agenda. The financial crisis has become so severe that it now seems highly likely that rates will need to be cut soon (in the next few months) in response to risks of extended economic weakness and eventual inflation undershoot. Given that, early easing (i.e. this week or next ) may help reduce risks of a really severe financial collapse and deep recession (depression?). Conversely, given evidence of sharp economic slowdown and downside risks, the risk seems quite small that early easing could represent excess stimulus that stokes up inflation risks. Longterm inflation exp ectations have fallen sharply in recent weeks. Costs of central bank inaction now probably outweigh the risks of early easing.
European central banks (all of them) usually move rates by 25bp rather than 50bp. But, in current severe conditions it may that the greater decisiveness of a 50bp move is more appropriate for some countries. After 9/11, emergency easing was a mix of 25bp or 50bp cuts and a similar sense of urgency may come through now as well.