06 October 2008

EZA 865 Report: ECB Observer

ECB 2 October Council Post-Meeting Assessment

ECB opens door to possible rate cut in next few months

· ECB's Governing Council kept key interest rates unchanged on 2 October but signals shift in focus from upside inflation risks to intensification of financial turmoil, economic weakening and diminished inflation impulse.

· No longer sees Q4 growth recovery from Q2/Q3 trough, but gradual recovery hoped for in the course of 2009, but downside risks from financial market turmoil have increased.

· Inflation level still worrying, seen moderating only gradually in 2009, with 'price stability' achieved in early 2010 but upside risks, although diminished, have not disappeared.

· Particular concern about strong wage growth and sharp rise in unit labour costs, with risks of second-round price and wage effects.

· ECB still insists on strict distinction between price-stability focus of monetary policy stance and liquidity provision in response to financial market turmoil.

· Governing Council "remains determined to secure price stability" and will "continue to monitor all developments very closely".

EZA Conclusion: The Governing Council has opened the door to a possible rate cut within the next few months as evidence of recession mounts and inflation risks recede but does not currently expect to move in November. A 25 bp cut at December meeting seems a likely bet, coinciding with new Eurosystem macro projections, but warnings about dangers of second-round effects not purely rhetorical and, should these materialise, a rate increase is still not altogether ruled out. A unilateral cut in rates purely as a response to market distress remains highly unlikely but a co-ordinated move at the initiative of the Federal reserve and other central banks if market melt-down appeared imminent is not entirely inconceivable.

© EZA