The European Central Bank is expected to cut interest rates for the third time in less than two months on Thursday, with opinions split on the odds of a tried-and-trusted 50 basis point cut or a more aggressive move.
Two-thirds of analysts in a Reuters poll expect the ECB to stick with past practice and lop 50 basis points from borrowing costs on December 4, taking the benchmark rate to 2.75%, its lowest in more than two years. But a significant minority, 24 out of 81 polled, see a 75 or even 100 basis point move at the Brussels meeting, one of two meetings a year held outside Frankfurt, due to a sharp dip in economic activity as well as inflation.
Markets are nearly fully pricing in a 75 basis point cut, more than the ECB has ever moved before in one go, according to EONIA interest rate contracts. The meeting comes against a backdrop of growing central bank concern about the impact the financial crisis is having on the real economy, with the Swedish and Japanese central banks both calling unscheduled meetings for this week.
Although the ECB has lowered rates twice since early October, the U.S. Federal Reserve, the Bank of England and the Swiss National Bank have all cut by more. The Bank is also expected to reduced British rates again by at least 50 basis points on Thursday. The euro zone has fallen into recession and recent slides in sentiment and employment give no hope of a recovery soon. Annual inflation, for its part, plummeted to 2.1% in November from 3.2% a month earlier.
Economists said the ECB was likely to steer clear of a bumper cut and opt for a third consecutive 50 point move, while signaling that more loosening in 2009 is still an option. “From the perspective of the data I think you can make a case for a larger move but what keeps me in the 50 basis point camp is ... their very strong sense of a medium-term anchor leading to a measured, disciplined, gradualist approach,” Deutsche Bank economist Mark Wall said. “It’s a different approach to policy than we are seeing at other central banks. We have had two (cuts) quickly. If we have 50 this week, it will be 150 basis points within two months which in other circumstances would be applauded.”
Since the last ECB meeting on November 6, several ECB policymakers, including Lorenzo Bini Smaghi and Yves Mersch, have warned that aggressive moves can backfire for confidence and the ECB should keep some firepower in reserve. But Germany’s Axel Weber fanned bets on a 75-point move by saying there was “ample” room to cut rates due to receding price pressures and the worsening growth outlook.
STAFF PROJECTIONS KEY
New ECB staff projections for both growth and inflation are expected to be cut sharply from the September round, and will be closely scrutinized for clues on the path of rates next year. The projections -- which include input from euro zone national central banks as well as the ECB’s own staff -- will also cover 2010 for the first time.
Economists generally expect rates to trough at 1.5% in the Q3, but Goldman Sachs economist Erik Nielsen said the ECB could go as low as 1% if staff projections are very pessimistic. “We expect the ECB to cut rates by 50 bp on Thursday. The joker in the game this time is the new staff forecast which might sway members towards an accelerated path,” said Nielsen.
After taking into account distortions resulting from the abnormally low level of overnight interbank and swap rates, EONIA pricing shows traders think ECB borrowing costs will trough at 2% in the second quarter of next year. Overnight interbank lending rates, for example, were fixed on Monday at 2.92%, 33 basis points below the ECB’s benchmark refinancing rate.
In September, staff saw 2009 growth of 0.6-1.8% but recent forecasts from the International Monetary Fund and the Organization of Economic Cooperation and Development both show a contraction of around 0.5% in 2009. This would be the worst economic performance since 1993, when the economy of the 15 nations which now make up the euro zone shrank 0.8% as the German post-unification boom collapsed, although budget stimulus may provide some boost to the economy.
Economic sentiment in the region hit its lowest level since 1993 in November and manufacturing and services activity hit record lows, with further weakness expected. Despite the weaker euro, euro zone exporters will suffer as the market crisis hurts demand in major emerging market trading partners such as Russia and China, as well as the UK and the United States.
Still, in one positive sign, consumer confidence improved in Germany and France in November on the back of lower inflation, which boosts consumer spending power. The staff forecasts may show inflation averaging less than the ECB’s 2% price stability ceiling for the first time since 1999.
The median expectation of economists in Reuters poll in mid-November was for an economic contraction of 0.4% next year and inflation of 1.7%. (Reuters)