Finally – The Penny (or ‘Cent’) Drops

The European Central Bank cut its main re-financing rate last week by 50 basis points to 1.50%.  It is continuing to ease monetary policy into uncharted waters. Jean Claude Trichet conceded that the ECB staff’s projections for a recovery in 2009 were way too optimistic and now envisage only a “gradual recovery” – in fact, the ECB now expects flat growth in 2010 and a negative GDP print of somewhere between -3.2% & -2.2% in 2009. Inflation is also “expected to remain well below 2% over 2009 & 2010 ” and clearly leaves the door open for further rate cuts. These are all significant changes to what we were hearing from the ECB only a month or so ago.

I’ve been saying for some time (see here for a comment from September for example) that the ECB’s concerns about spiralling inflation were misplaced. The ECB now finds itself in a very difficult situation having stubbornly maintained a tight monetary policy; even absurdly hiking rates in July of last year. With consumer and business confidence remaining very weak, unemployment rising, lending slowing, a relatively strong currency & real concerns about a number of Eastern European economies, the ECB has its work cut out.

Not surprisingly JCT came under a lot of pressure to discuss quantitative easing (QE) during his Q&A session. Whilst he claimed that the ECB is already conducting “non-standard measures” and stated that the Governing Council are “discussing and studying possible new non-standard measures,” my sense was that we are unlikely to see large scale purchases of Eurozone government bonds in the near future. Clearly the ECB finds itself with less room to manoeuvre than the Bank of England and the Fed in this respect, but it may find its hand forced should the economy continue to deteriorate at the rate we are currently witnessing.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Stefan Isaacs

Job Title: Deputy CIO Public Fixed Income

Specialist Subjects: Bonds

Likes: Football, travel and the prospect of retirement

Heroes: Sir David Attenborough, Bill Shankly and Theodor Herzl

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