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Thursday November 6, 2008 - 15:07:45 GMT
Larry Greenberg -

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Reflections on today's ECB's Rate Decision

The ECB had been projected to cut rates by 50 basis points and did so. But the move was only a third as forceful as the Bank of England’s and in that context appears to timid. A 75-basis point cut was also considered and should have been chosen instead. Governing Council members were unanimous in their decision, according to the ECB President, Jean-Claude Trichet. Total rate cuts from peak by the ECB total 100 basis points, compared to reductions from peak of 425 basis points by the Fed, 275 bps by the Bank of England, 225 bps by the Bank of Canada, 200 bps by the Reserve Bank of Australia, and 175 bps by the Reserve Bank of New Zealand. Central banks in Norway, Sweden, and Korea cut rates also by 100 bps, while reductions from peak in China, Switzerland and Japan amount to 81 bps, 75 bps and 20 bps.

The ECB statement released today maintains that price risks in the all-important medium-term horizon are still skewed to the upside, only less so than before. The restoration of price stability, that is CPI inflation below but close to 2.0%, is expected sooner than thought when formal forecasts were last issued two months ago. Such is now forecast to occur sometime in the course of 2009. In fact, inflation is likely to dip very sharply in 2009, but temporarily and thus not in a way that will influence monetary policy. Monetary analysis appears to be the main factor imposing an upward bias to price risks. The legacy of the Bundesbank alas lives on. Although decelerating, broad money and credit growth remains “strong,” and “up to September there were no indications of a drying-up in the availability of bank loans to households and non-financial corporations.” The second main upside price risk stems from wage indexation schemes that have not been abolished despite prior repeated ECB urging. Other risks involve another the possibility of another commodity price upturn and the behavior of indirect taxes and administered prices. The economic recession apparently mitigates but does not reverse these risks.

Surprisingly little is said about economic growth. Tensions are said to have spread in two ways, from financial market turmoil to real activity and demand and from advanced economies to emerging ones. In an understatement, the statement claims that survey data “confirm that momentum in economic activity has weakened significantly, with sluggish domestic and external demand and tighter financing conditions.” Earlier today, a release in Germany revealed a plunge in all industrial orders of 14.6% at a seasonally adjusted annualized rate during 3Q08 including a drop of 27% saar in foreign orders for capital goods. That was before an extremely frightful October.

By cutting just 50 basis points today, the refinancing rate of 3.25% is just 75 basis points lower than its level in 1H08. Another reduction, probably by 50 bps again, seems unavoidable next month. There always is a possibility of an inter-meeting move sooner, but it is unlikely. The ECB only did such last month in concert with other central banks, but the Fed’s rate is now so low that an inter-meeting reduction has only a small chance, and without Fed participation, a concerted round of simultaneous central bank rate cuts appears doubtful.

The Swiss National Bank cut its rate by 50 bps earlier today, no doubt anticipating the ECB action and wishing to avoid upward pressure on the franc. The Bank of Korea is poised to ease further tomorrow. Denmark, on the other hand, is in difficult circumstances. Rates there have actually had to be raised to defend the krone and help conserve foreign exchange reserves, which dropped extensively last month. The government will try again to submit a referendum to voters to approve having Denmark join EMU and exchange the krone as the national currency for the euro.


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