What is the European Central Bank waiting for?

The ECB cut rates from 1.5% to 1.25% last week, taking the main rate to the lowest level since the ECB took control of monetary policy in 1999.  Markets had been expecting a rate cut to 1%, and rightly so.

Everything seems to be deteriorating in Europe, almost without exception.  The euro is close to the strongest it has ever been versus a basket of foreign currencies, and this is killing exports (in January for example, German exports to non-EU countries were down 24.5% on a year earlier).  Euro-zone Q4 GDP was revised down to -1.6% today, meaning that the economic slump in Q4 was just as bad for the region as for the US and the UK.  Unemployment was 8.5% in February and is expected to exceed 10% quite soon.  Consumer confidence fell to a record low in March.  The reluctance of Europe’s leaders to provide additional fiscal stimulus is doing little to improve things.

Meanwhile, on the money side, inflation has fallen to 1.2% and is very likely to fall further (Spanish consumer prices are already falling).  The rate of lending growth is dropping sharply – loan growth to households and companies was the weakest in 14 years in the year to February.  Worryingly (see why here), the growth of money supply has fallen to 6% year on year, about half the rate at the beginning of 2008.

So what is the ECB waiting for? Did they go for a 0.25% rate cut because of some sort of compromise?   Perhaps they’re hoping for extra stimulus elsewhere.  It does seem likely, though, that they’re going to begin quantitative easing after Trichet referred to the need for “unconventional measures”.  What this will look like in Europe is difficult to predict though – whose government bonds should the ECB buy?  Will they focus just on buying corporate bonds, and if so, which bonds?  If they do buy corporate bonds, will it really make that much difference given that European companies are less reliant on issuing bonds, and more reliant on bank lending?

We’ll probably get some idea next month, although there’s likely to be a lot of disagreement between members on the best course of action.  Whatever happens next, the ECB’s inactivity so far demonstrates the problems of attempting to arrive at an economic decision via group political consensus, where different countries have different desires.


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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