ECB Preview: What to Expect

Of all the major central banks in the world, the ECB has been one of the least aggressive. Since the beginning of 2008, they have cut interest rates by only 150bp, an insignificant amount when compared to the actions taken by the BoE and the Fed.

The ECB has been close lipped about how much they plan to cut interest rates, but the market is pushing for a 50bp rate cut that would take Eurozone interest rates down to 2 percent. However given the track record of the ECB, there is no doubt that central bank President Trichet would postpone additional rate cuts if it were in any way possible. In comments made today, while acknowledging the severe economic downturn, he seems optimistic in a full recovery by 2010. The central bank head has also repeatedly supported the fact that his string of rate cuts has not yet been acknowledged by the financial markets. It is a monetary reality that interest rate decisions made by central banks have a lagging impact on an economy, often taking more than six months to reveal possible effect. However, the fact of the matter is that the lack of action will leave the Euro-zone very vulnerable in the event that the situation worsens. Therefore we wouldn't completely rule out a 25bp rate cut or a half point cut accompanied with not so dovish comments.

The economic condition of the Euro-zone has only managed to worsen since last month's meeting. EZ PPI fell by the most in three-decades, Industrial Production dropped by the most in eighteen years while German unemployment rose for the first time in nearly three years. This serves as a severe shock to business and consumer confidence which Trichet personally promotes as a vital ingredient for his optimistic turnaround by 2010. With nearly all EZ countries struggling within the clutches of recession, the ECB will have to act fast to prevent another round of financial destruction.

Ratings Downgrades in the Eurozone

The Euro has also been hit by Standard and Poor's downgrade of Greece's sovereign debt rating to A- and rumors that Ireland may seek help from the IMF. The downgrade of Greece follows official warnings about potential downgrades for Spain, Ireland and Portugal. Falling tax receipts has made the ratings agency extremely concerned about the budgets of these nations. A downgrade increases the cost of borrowing for Greece which puts the country at greater risk. As for Ireland, they have denied that they will seeking IMF funding, but the rumors reflect the market's concern about the economy.