Mon dieu, the euro’s trading at a five-week low ahead of the European Central Bank’s interest rate meeting today.
Consensus is for a 50bp reduction in the current official rate of 2.5 per cent, but some are predicting deeper cuts of 75bp or even 100bp.
Tipping the balance of favour towards a deeper cut is a slew of recent – sehr schlechte — economic data, including, for instance, the tidbit that Germany’s GDP may have contracted by as much as 2 per cent in the fourth quarter. The ECB’s December projections are looking increasingly out of date, including that very optimistic forecast that eurozone GDP will contract a mere 0.5 per cent in 2009, not to mention their inflation projection of 1.4 per cent.
However, noises out of ECB council members have been more confusing than usual of late. Indeed, the current situation is very reminiscent of sentiment ahead of that December cut. In November council members said they didn’t want to reduce rates at their next meeting by more than 50bp. Then, voilà, come Dec 4th, they slashed the rate by 75bp, saying, by way of explanation, that they didn’t want to have to ease again in January. Sehr verwirrend.
Bank of America economist Holger Schmieding has picked up on the confusione.
We do acknowledge that the recent signals from the ECB have been very mixed. A number of council members – believing that excessively low central bank rates in 2003-2005 laid the basis for the current financial and economic calamities – are very reluctant to ease further. Still, the data show that the situation is now so much worse than in 2003 that rates below the current 2.5% have to be part of the crisis response, in our view. As possible compromises between doves and the residual hawks, the ECB could:
* cut rates by 50bp tomorrow but suggest that it does not intend to cut rates again immediately thereafter and/or that future cuts would be by 25bp only,
* cut rates only by 25bp but hold out the prospect for further easing in three weeks at the 05 February meeting,
* stay on hold but signal a likely 50bp rate cut for 05 February.
Of these three options, we consider the first one, namely a 50bp ease combined with a “wait and see” signal for the immediate future, the most likely. It simply would be too difficult to explain to the public, to politicians and to the community of global central bankers why, after such a drastic change in the outlook for GDP and inflation within the last six weeks, the central bank stays put or shifts merely from 2.50% to 2.25%. Of course, the other options cannot be ruled out completely. After all, this is the ECB.
Indeed — and the ECB, as we know, is torn by increasingly divergent interests (notably between PIGS and larger members). The MIT’s Simon Johnson, incidentally, has an interesting presentation on the ECB’s mindset and the implications for the future of the eurozone.
Related links:
Simon Johnson: The likely future of the eurozone – The Long Room