ECB Rate Decision: Preview

Rate decision: Thursday 2 May 2013, 12.45pm (BST)
Press conference: Thursday 2 May 2013, 13.30pm (BST)

CONSENSUS EXPECTATIONS

Forecast: Where will the ECB interest rate be after its policy meeting on 2 May?
Median: 0.50%
High: 0.75%
Low: 0.25%
Number of forecasts: 70
(Source: Bloomberg)

INTRODUCTION

Recent Eurozone economic data has fuelled speculation that the European Central Bank (ECB) will slash its benchmark interest rate at the conclusion of its next policy meeting on 2 May to help spur economic growth within the region.

Dismal employment data, weaker PMI readings, and below target inflation is confirmation that the Eurozone still faces significant obstacles to achieving economic growth. In addition, dovish comments from the ECB at its April meeting suggest that the central bank may be inclined to take action soon.

CASE FOR A RATE CUT

At its previous policy meeting, the ECB argued that weaker than expected data may lead it to consider easing monetary policy, putting downward pressure on the euro. And recent data certainly supports the case for a rate cut.

Unlike the US Federal Reserve, the ECB does not have a mandate to target unemployment. However, data released this week shows Eurozone unemployment now stands at a record high of 12.1%, which will not have escaped the bank’s attention.

Data this week also shows that the Eurozone consumer price index measure of inflation eased sharply to a 38-month low of 1.2% – far below the ECB’s inflation target of 2%. Howard Archer, chief European and UK economist at IHS Global Insight, said: “Consumer price inflation at just 1.2% in April is now markedly below the ECB’s target rate of just below 2%, thereby giving the ECB ample scope to take interest rates lower.”

And although Eurozone flash composite PMI was unchanged in April at 46.5, the reading below 50 still suggests that economic activity is contracting, further supporting the case for a rate cut.

Additionally, arguments against austerity within the Eurozone are gaining volume. In his inaugural speech to parliament this week, Italy’s new prime minister Enrico Letta joined the choruses of those calling for less austerity and more pro-growth policies, saying: “Italy is dying from austerity alone. Growth policies cannot wait.” And while it is unlikely to be a panacea, a rate cut may have a stimulating effect on the Eurozone’s economy.

Thomas Harjes, an economist at Barclays, said that looser monetary policy may benefit both periphery nations and core nations: “Although there are signs that the pace of economic contraction may be slowing in southern Europe, weakness appears to be increasingly spreading to the large core economies, including France and even Germany,” as reflected by the downward correction in German IFO surveys.

The doves are expecting a cut between 25bps and 50bps, and UBS forecasts that a cut of 25bps to 0.50% may bring the euro down to the $1.28 to $1.30 against the dollar.

CASE AGAINST A RATE CUT

More hawkish analysts question whether a rate cut will have any real effect on boosting economic growth within the Eurozone. In a note, Societe Generale said: “market consensus is for a 25bp rate cut on Thursday, but both the ECB and market experts agree that the widely expected move would have no impact.”

Carsten Brzeski, senior economist at ING Bank, agrees, saying “it is an open secret that the ECB itself considers a rate cut rather ineffective and mainly symbolic. Moreover, the ECB’s current focus is the malfunctioning transmission mechanism – as long as this mechanism is not working, a rate cut would simply go up in smoke and could soon look like a last act of desperation.”

And while Eurozone economic data leaves a lot to be desired, stability is returning after the Cyprus crisis and the Italian general elections. The Cypriot government has rubber stamped its bailout programme, and Italian 10-year BTP yields dipped below 4% this week – the lowest since November 2010 – after it finally formed a government. Both mitigate the two major headwinds that were shaking the Eurozone in 2013.

If the ECB did not slash rates on 2 May, analysts from Bank of America Merrill Lynch argue that the reaction will be “knee-jerk positive for the euro”.

However, calls for a rate cut are not based on enhancing Eurozone stability. On the contrary, they are due to weakening economic conditions. If we do not get a rate cut on 2 May, Howard Archer of HIS Global Insight argues that “if the ECB does hold fire on interest rates next Thursday, it is very likely only delaying the inevitable”.

A POSSIBLE BOOST TO SMES

Societe Generale has identified the “financial fragmentation” across the Eurozone as a key issue holding back growth. And, as such, many are expecting the ECB to begin credit easing to SMEs.

An “SME bazooka,” as some have called it, may help to tackle inefficiencies in monetary policy transmission, as well as supporting SMEs in the Eurozone’s periphery. This could come in the form of loan guarantees, or a loosening of the collateral frameworks targeting loans to SMEs.

However, some question whether the policy is ready to be unveiled. Brzeski points out that “an SME funding scheme would not be easy to construct, as it touches upon the question of who will take the risk from SME loans.” Will it be the ECB? Will it be member states, or institutions like the European Investment Bank? Or will it stay with individual banks? Many of these questions will need addressing before the scheme can be rolled out.

Analysts at Credit Agricole, therefore, “suspect that the ECB will avoid making any formal statement on a potential SME programme [on 2 May] as it continues to weigh up the pros and cons of such measures”.

And whether easing lending to small businesses will have a pronounced impact on generating growth, Kit Juckes, an economist at Societe Generale, says “Measures to reinvigorate lending to SMEs through a securitisation market would be a big plus… But would that be enough to avoid a sell-off for the Euro and for the front end of the Euro curve? I doubt it. Likewise, even a 25bp rate cut may no longer be enough to move forward rate agreements, Euribor futures and short-dated swaps.”

RECENT COMMENTS FROM GOVERNING COUNCIL MEMBERS

Apr22 - Vitor Constancio (ECB Executive Board) said: “Inflation was coming down rather significantly... And that’s an important factor of course for us, because inflation is always the first consideration.”

Apr20 – Ewald Nowotny (Austria), on possible future interest rate cuts, Nowotny said: “It’s still too early. In Europe, we have very expansionary monetary policy and it is too early to judge if further steps should be taken.”

Apr17 – Jens Weidmann (Germany), “As we didn’t change interest rates at our last meeting, this means that we consider our monetary policy stance still appropriate. We might adjust in response to new information. But again, interest rates in the euro area are historically low. Monetary policy is already quite expansionary, and I don’t think that the monetary policy stance is the key issue.”

Apr11 – Benoit Coeure (ECB Executive Board), on SME funding: “The ECB does not have a magic wand... The ECB has taken and will continue to take appropriate measures to ensure that bank funding is not a source of financial fragmentation or an impediment to bank lending.”

Apr9 – Josef Bonnici said: “It is true that interest rates are already very low so any marginal gain from further cuts is probably not of great significance, although it could have a positive impact... But at this stage one has to ensure non-standard measures are operating well.”

CONCLUSION
In summary, Mansoor Mohi-uddin, head of foreign exchange strategy at UBS, says: “Chatter from ECB officials has risen significantly. Board Member Asmussen said an interest rate cut was possible. Dutch central bank governor Knot said the ECB still has measures at its disposal. Bundesbank President Wiedmann said the ECB may reassess interest rates if economic data changes. ECB Vice President Constancio said inflation is coming down ‘rather significantly.’ President Draghi said the ECB hasn’t seen an improvement in the data in the past two weeks.”