The recent decision by the European Central Bank (ECB) to cut rates by 75 basis points to 2.5 per cent in one go and by 175 basis points in less than two months is aggressive by ECB standards but still cautious in comparison with the 100 basis points or more moves by the Bank of England (BoE), the Riksbank, the Reserve Bank of Australia, and the Reserve Bank of New Zealand.
After such aggressive moves the markets anticipated a more balanced tone from Mr Trichet, but in the event there was little new in the opening statement, other than the further significant downward revisions to the ECB staff projections. These point to a contraction in the 2009 full-year GDP of 0.5 per cent.
The interesting comments occurred late in the press conference when Mr Trichet, in response to numerous questions about future rate moves, responded in a way that suggests that the ECB may not follow up with a further cut in January.
Comments by Mr Trichet that the governing council needs time to "observe that what they are doing is effective" and "concentrate on getting what we have decided operational" point to a pause in rate cuts in January. He also suggested that the onus of monetary stimulus will not all be on policy rates, as the ECB needed to be wary of rates "being trapped at nominal levels which are too low". On quantitative easing, he highlighted that the ECB had been at the forefront of liquidity provision since the crisis began and that he would not exclude any further measures. The ECB mandate allows it to make outright purchases of debt securities and he also indicated that a number of other possibilities are being examined currently.
The new set of growth forecasts were a bit weaker than expected, with the mid-point of the range for 2008 lowered to 1 per cent (from 1.4 per cent) and for 2009 down to -0.5 per cent (from 1.2 per cent). GDP growth in 2010 is seen at 1 per cent. Mr Trichet made it clear that although there are a number of downside risks to growth, the ECB remains of the view that the economy will begin a gradual recovery in the second half of 2009. On inflation, the mid-points of the average projections are 1.4 per cent in 2009 and 1.8 per cent in 2010.
The markets expect the next 50 basis points cut in February assuming there is no renewed surge in interbank spreads in the next few weeks. The ECB's commitment to provide unlimited liquidity should prevent a repeat of last end-year's seizure in money markets. However, if it does not, the ECB could have little choice but to use the policy rate again. Further gradual reductions to 1.5 per cent are seen by mid-2009.
A level of 1.5 per cent rates would be unprecedented in the ECB's short history, but so too has been the ongoing destruction of household wealth and the apparent collapse in activity, both within the eurozone and in key trading partners. The main reasons for expecting further rate cuts include:
Sharply weaker eurozone activity: The quarterly GDP contraction in the fourth quarter of 2008 will be large. Based on the survey data, the worst case scenario is possibly as bad as -1.8 per cent quarter-on-quarter while the best case scenario points to readings around -0.7 per cent.
Weaker outlook for external demand: Global demand has softened further and the 2009 outlook for key oil-producing export destinations has deteriorated markedly with the current level of oil prices pointing to a dramatic slowdown in GDP. For the eurozone the strong export demand from central and Eastern Europe, Russia, Turkey, the Middle East and Asia can no longer be relied upon to offset the weaker demand from the UK in the way that it has over the past year.
Falling inflation: The eurozone's flash inflation estimate for November fell to just 2.1 per cent, down from 3.2 per cent in October, and assuming stable oil prices will fall easily below 1 per cent in mid-2009. Even based on the upward sloping oil futures curve which the ECB uses to make its projections, inflation will be at target in 2009-2010. But the eurozone is still a long way from deflation or the risk of it. Note that the ECB, despite its downbeat growth outlook still sees inflation at 1.8 per cent in 2010. In other words, only just at target in what will be the third consecutive year of sub-trend growth.
Ongoing financial market strains: Inter-bank rates are still edging down, but largely on the expectation of further cuts - spreads are still elevated and corporate bond yields (BBB) at 8.8 per cent are about 300 basis points above their level of even a year ago. Improvement would need to be dramatic in the next month or two to prevent the need for the ECB from needing to continue lowering the policy rate.
Global policy cooperation: There are also signs of international co-operation in the current global easing cycle. Although the ECB has always underlined its independence domestically and internationally and this is far from being the primary reason for projecting more aggressive moves, a sense seems to have emerged that the current crisis has to be fought "together".
This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.
After such aggressive moves the markets anticipated a more balanced tone from Mr Trichet, but in the event there was little new in the opening statement, other than the further significant downward revisions to the ECB staff projections. These point to a contraction in the 2009 full-year GDP of 0.5 per cent.
The interesting comments occurred late in the press conference when Mr Trichet, in response to numerous questions about future rate moves, responded in a way that suggests that the ECB may not follow up with a further cut in January.
Comments by Mr Trichet that the governing council needs time to "observe that what they are doing is effective" and "concentrate on getting what we have decided operational" point to a pause in rate cuts in January. He also suggested that the onus of monetary stimulus will not all be on policy rates, as the ECB needed to be wary of rates "being trapped at nominal levels which are too low". On quantitative easing, he highlighted that the ECB had been at the forefront of liquidity provision since the crisis began and that he would not exclude any further measures. The ECB mandate allows it to make outright purchases of debt securities and he also indicated that a number of other possibilities are being examined currently.
The new set of growth forecasts were a bit weaker than expected, with the mid-point of the range for 2008 lowered to 1 per cent (from 1.4 per cent) and for 2009 down to -0.5 per cent (from 1.2 per cent). GDP growth in 2010 is seen at 1 per cent. Mr Trichet made it clear that although there are a number of downside risks to growth, the ECB remains of the view that the economy will begin a gradual recovery in the second half of 2009. On inflation, the mid-points of the average projections are 1.4 per cent in 2009 and 1.8 per cent in 2010.
The markets expect the next 50 basis points cut in February assuming there is no renewed surge in interbank spreads in the next few weeks. The ECB's commitment to provide unlimited liquidity should prevent a repeat of last end-year's seizure in money markets. However, if it does not, the ECB could have little choice but to use the policy rate again. Further gradual reductions to 1.5 per cent are seen by mid-2009.
A level of 1.5 per cent rates would be unprecedented in the ECB's short history, but so too has been the ongoing destruction of household wealth and the apparent collapse in activity, both within the eurozone and in key trading partners. The main reasons for expecting further rate cuts include:
Sharply weaker eurozone activity: The quarterly GDP contraction in the fourth quarter of 2008 will be large. Based on the survey data, the worst case scenario is possibly as bad as -1.8 per cent quarter-on-quarter while the best case scenario points to readings around -0.7 per cent.
Weaker outlook for external demand: Global demand has softened further and the 2009 outlook for key oil-producing export destinations has deteriorated markedly with the current level of oil prices pointing to a dramatic slowdown in GDP. For the eurozone the strong export demand from central and Eastern Europe, Russia, Turkey, the Middle East and Asia can no longer be relied upon to offset the weaker demand from the UK in the way that it has over the past year.
Falling inflation: The eurozone's flash inflation estimate for November fell to just 2.1 per cent, down from 3.2 per cent in October, and assuming stable oil prices will fall easily below 1 per cent in mid-2009. Even based on the upward sloping oil futures curve which the ECB uses to make its projections, inflation will be at target in 2009-2010. But the eurozone is still a long way from deflation or the risk of it. Note that the ECB, despite its downbeat growth outlook still sees inflation at 1.8 per cent in 2010. In other words, only just at target in what will be the third consecutive year of sub-trend growth.
Ongoing financial market strains: Inter-bank rates are still edging down, but largely on the expectation of further cuts - spreads are still elevated and corporate bond yields (BBB) at 8.8 per cent are about 300 basis points above their level of even a year ago. Improvement would need to be dramatic in the next month or two to prevent the need for the ECB from needing to continue lowering the policy rate.
Global policy cooperation: There are also signs of international co-operation in the current global easing cycle. Although the ECB has always underlined its independence domestically and internationally and this is far from being the primary reason for projecting more aggressive moves, a sense seems to have emerged that the current crisis has to be fought "together".
This report was compiled by the Marketing Department of HSBC Bank Malta plc on the basis of economic research and financial information produced by HSBC International Bank.