Release: ECB Interest Rate Decision
Consensus Forecast: 0.5%
Current Rate: 0.5%
Date/Time: 1/12/12 (7:45 AM ET; 12:45 GMT)
ECB Not Expected to Pursue Further Easing This Time Around:
The European Central Bank is not likely to cut interest rates further in its meeting on Thursday and it also does not look likely that they will undertake further stimulative measures following its December action to offer the European banking system three-year loans at 1%.
The ECB would like to see the impact of its 50 basis point cuts from the previous two meetings as interest rates are now at a record low of 1%, and it would be a big deal to cut them further at this point. ECB President Draghi the doesn't want to look like a complete inflation at this point and the LTRO operations was a big enough boost to the European banking system that it has helped to calm funding pressures in the near-term.
Therefore, with no cuts or stimulative measures expected we will be looking at the Governing Council's interpretation of the incoming data. If growth forecasts from the ECB deteriorate further and inflation forecasts are revised downward - with any potential for deflation, or negative prices - that will give us clues that the ECB may be ready to offer lower rates and more stimulus in subsequent meetings in the 1Q, with a rate cut coming perhaps in March.
By lowering growth and inflation projections the ECB would in effect be talking down the Euro.
Inflation Eases in Euro-zone
With inflation having eased in December to an 2.8% annual pace from 3% in November, and weaker growth/austerity prospects expected to put further downward pressures on prices throughout this year, the ECB will likely show some concern for prices falling below its target of just below 2% during the middle of this year.
We have heard from some ECB Governing Council members - for instance Bini Smaghi - that in a deflationary environment, quantitative easing may be a appropriate policy tool - something that the ECB has certainly shied away from even in their face of consistent pleadings from politicians, banks, and economists and analysts for to do just that.
From SFGate: I do not understand the quasi-religious discussions about quantitative easing, Bini Smaghi, who will leave his post at the end of the month, said in an interview published yesterday by the Financial Times. The ECB confirmed the comments. It is appropriate if economic conditions justify it, in particular in countries facing a liquidity trap that may lead to deflation.
Central banks are given a clear mandate, to achieve price stability, and the independence to achieve it through the instruments they consider most appropriate, Bini Smaghi said. If conditions changed and the need to further increase liquidity emerged, I would see no reason why such an instrument, tailor made for the specific characteristics of the euro area, should not be used.
Just today Fitch said that if the ECB does not step up its government purchases could lead to a cataclysmic disaster for the euro, so the drumbeat for the ECB to undertake printing of money to buy bonds continues to grow.
Euro-zone Already in Recession According to Economists, Macro Data
At the same time growth expectations certainly weakening. 48 out of 50 economists polled by the Wall Street Journal said that the euro zone is already in recession and the German Federal Statistics Office said that Germany's economy likely contracted 0.25% in the fourth quarter.
With manufacturing and services PMI's remaining in contractionary territory for a fourth straight month the outlook for the real economy is certainly a bleak one for this year. This will only be compounded by austerity measures by the periphery countries and a contraction in bank lending by European financial institutions that need to meet new capital requirements.
3 Key Scenarios for the Interest Rate Decision
1. No Cuts - Forecasts for Growth and Inflation Revised Lower:
With the most recent incoming data and the spread of the sovereign debt crisis to the European banking sector its likeliest that the ECB will lower its growth projections as well as inflation forecasts and that the market will take away from that that the ECB will be ready to lower rates in February or March.
Lower interest rates are a negative fundamental factor for the euro and will likely pressure the euro both in the short term and in the medium-term. The prospects for the euro zone to get a handle on its debt crisis the of growth will also seem like a very slim possibility.
2. ECB Says Current Measures Are Enough:
While the likely scenario above plays out in that the ECB lowers its growth and inflation forecasts, the governing Council and President Draghi may surprise the markets and say that current actions are sufficient and that lower interest rates are not needed, and that the recent steps taken to add liquidity to the banking sector is an adequate response.
Part of the thinking here is that the banks while showing a very strong uptake for the 3-year LTRO loans have basically parked that money at the ECB, and that more liquidity would just likely find its way to the ECB deposit facility and not to the real economy.
However the fact that the ECB is not willing to provide more stimulus could have a negative impact on risk sentiment and weaken European equities and by extension the euro. Therefore, there are two opposing forces at play - from the short-term and the medium-term - and without further stimulus the expectation would be that the economic situation would only further deteriorate in the real economy.
3. ECB Cuts Rates - Add More Stimulus -
If the ECB wants to be extremely proactive about combating the euro zone recession the Governing Council could surprise markets and decide to lower interest rates in Thursday's meeting another 25 basis points to 0.75%.
This would be a fresh record low and would again create opposing forces for the euro.
From a interest-rate differential perspective it would be a negative fundamental development for the euro in the medium-term and would further the perception that the euro may become a funding currency for carry trade against commodity currencies like the AUD and CAD (Canada, at 1%, would have a higher interest rate than the ECB).
In the short term, a surprise rate cut could help boost equities and risk sentiment within Europe which would have a positive short-term impact on the euro.