20 January 2009

EZA 878 Report: ECB Observer

ECB 15 January Council Post-Meeting Assessment

· As we foresaw, the ECB cut its main refinancing rate by 50 basis points on 15 January, taking it to 2% w.e.f. 21 January.

· Trichet said this decision was partly in response to the diminution of inflation risks as a result of the economic downturn so far but partly also in anticipation of a further alleviation of inflation risks resulting from an expected further weakening of the economy.

· Inflation risks were now seen as broadly balanced, while risks to economic growth remained clearly on the downside.

· Trichet again warned that inflation could fall to very low level sat mid-year, but this would reflect temporary statistical base effects and inflation was likely to increase again in H2.

· Moderating monetary growth supported the view that inflationary pressures and risks were diminishing.

· Noting that at 2% the ECB's 'refi' rate was the lowest it had ever been, Trichet said that was not to say it could not go down further, but the Governing Council did not intend to find itself in a liquidity trap.

· With the 5 February Governing Council meeting only three weeks away, the next important meeting for monetary policy would be on 5 March.

 EZA Conclusion: Even though, in deciding on a 50 bp cut this time, the Governing Council were in part anticipating a further deterioration in economic prospects, the ECB's present economic and monetary analysis and the expected downward revision of the Staff's macroeconomic projections keep the door open for a further rate cut in March. In discounting the notion that the Governing Council regarded 2% as a lower bound for the 'refi' rate and in pointing to March as the next important policy meeting, Trichet implies that they could well consider cutting rates then. In EZA's view, this is the most likely outcome, with a cut of 50 bp to take the 'refi' rate to 1 1/2%. A 25 bp cut would seem too feeble in current circumstances, while 75 bp would take the 'refi' rate uncomfortably close to the floor of 1%, below which we believe the ECB would rather not venture and the rate on the ECB's deposit facility very close to zero. With a 50 bp cut in March, the ECB would still retain one more shot in its locker
 

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