The ECB has signalled that a rate cut is likely at the upcoming meeting in early March and we feel that a half-point reduction is in store, taking the repo rate to a new cycle low of 1.5%.
- A half-point cut is likely in March
- Further reduction probable given outlook
“The ECB has signalled that a rate cut is likely at the upcoming meeting in early March and we feel that a half-point reduction is in store, taking the repo rate to a new cycle low of 1.5%. This may not be the floor, moreover, as unfolding events have increased the probability that euro area interest rates may fall to 1% over the next few months”, according to Bank of Ireland’s February Bulletin which was published today, Friday 27 February 2009.
Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said: “The eurozone economy contracted by 1.5% in the final quarter of 2008, which still left the average growth rate for 2008 in positive territory, at 0.7%, but pulled the annual growth rate in Quarter 4 to -1.2%. The carry-over effects alone imply that the average growth rate in 2009 will be negative, but the first quarter is also shaping up to deliver another sharp contraction with the result that the consensus forecast for euro GDP this year is slipping lower, and is now approaching -2.0%. The ECB forecast, published in December, had projected a decline of 0.5%, so a substantial downward revision is inevitable at the March meeting, which will give the Governing Council the rationale for a half point move.
“This would still leave euro official rates above that of the UK (1%) and well above the US (0-0.25%), although the nature of European Monetary Union means that policy-makers in these other economies have far more flexibility in implementing other measures to kick-start growth in the money and credit aggregates. The Bank of England for example, is seeking Treasury approval to boost the money supply by buying assets from the banking sector, including Government bonds, and the US authorities now have a plethora of programmes operating with the aim of resuscitating economic activity.
“Some euro member governments have announced expansionary fiscal measures, of course, but it would be difficult for the ECB to mimic the Bank of England and start to purchase corporate or Government bonds in the market. As such bonds are issued by sovereign states or entities residing in specific states, so any purchases would have significant implications for sovereign bond spreads. This then puts more emphasis on the traditional tool of monetary policy, interest rates, and in the absence of a pronounced change in business and economic sentiment, the ECB may well have to ease monetary policy further over the coming months.
“A fall in the euro since the turn of the year has helped, and a further depreciation looks likely, but this alone may not suffice. It is reasonable to expect that real interest rates should fall to zero in a steep recession, which implies a nominal repo rate of 1% as the consensus forecast for inflation in 2009 is 1%. The expected inflation rate over the next few years as currently implied by 5-year inflation linked bonds is also around 1% so this should provide comfort for the hawks on the Governing Council”, concluded Dr. Dan McLaughlin.
27 February 2009
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Bank of Ireland
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