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ECB 4 December Council Post-Meeting Assessment
· As we foresaw, the ECB cut its key interest rates by 75 basis points on 4 December, taking its 'refi' minimum bid rate down from 3 1/4% to 2 1/2%.
· With financial turmoil spilling over to the real economy, real GDP contracted by a further 0.2% in Q3 and monthly indicators suggest further weakening of activity in Q4.
· Headline inflation has "declined substantially", to 2.1%, in November and, with lower commodity prices and weakening demand, inflationary pressures are diminishing further.
· Eurosystem Staff revise their macroeconomic projections sharply down, with inflation averaging 1.4% in 2009 and 1.8% in 2010 and real GDP falling by 0.5% in 2009 and growing by 1.0% in 2010.
· The level of uncertainty remains "exceptionally high", with risks to growth "on the downside", and upside and downside risks to inflation "now more balanced".
· Trichet warns that inflation rate could fall to very low levels in H1 2009, but this would reflect temporary statistical base effects and so would not warrant fears of deflation.
· "Sustained but moderating" monetary expansion supports view that inflationary pressures diminishing further, with some risks remaining on the upside".
· Need to make the cuts already undertaken more effective and for governmental measures already announced to be fully implemented.
EZA Conclusion: Acknowledging the extreme uncertainty about economic prospects in the present financial climate, the Governing Council remains open to further rate cuts in the next few months, possibly even as early as next month but would prefer to see first that what it has done so far, and what governments have committed to doing, is having some impact on money market conditions and the willingness of banks to lend. There is still room for manoeuvre on the interest rate front but the ECB is becoming wary of falling into a liquidity trap. This suggests it could countenance a further cut of 75 basis points, possibly in two stages, taking the 'refi' rate down to 1 1/2% during the first quarter of 2009. This would still leave some leeway for action if the threat of deflation appeared imminent.