ECB: Rate Cut In The Autumn?

Despite a widespread feeling that interest rates in Europe may be about to rise, futures markets seem near to pricing in a rate cut for the second half of the year.

One interesting knock-on consequence of this that no-one seems to be twigging is that any such move might well cramp the style of Alan Greenspan over at the US Federal Reserve. To date everyone is imagining that interest rates in the US will continue to rise at a ‘measured’ or ‘not so measured’ pace. But with the current account deficit to worry about there will be a limit to how far Greenspan can push the difference in rates (or spread) without driving up the dollar, something I’m sure he dearly wants to avoid doing.

In principle Jean-Claude Trichet was ruling it out last week, but many analysts remain unconvinced, and feel that the next move in ECB rates may be downwards.

“Let me again be absolutely clear; we are certainly not preparing, madame, for any rate cut, not at all.”

The problem is, for all the denials, the decision will really be a political one. The question is how much importance to give to the ill-fated German economy. Risks in the eurozone are not evenly balanced and there are assymetric downside risks involved in allowing German to wallow in the mire. The question will be how to weight those risks. Clearly any downward movement will be unpleasant news for any of the eurozone economies with an excess inflation problem, but that is part of the price you pay when you have a common currency:

Traders and investors had already ruled out any prospect of higher borrowing costs for the 12 countries using the euro. Now they are starting to bet that the Japan-style deterioration in the European economy may force an about-face from the ECB in the second half of this year.

The rate on the futures contract for June settlement has declined to 2.12 percent from 2.34 percent at the start of January, close enough to the ECB’s benchmark lending rate of 2 percent to show that few investors believe Trichet’s oft-repeated bulletins claiming rates are headed higher. The December contract, meantime, is down to 2.19 percent after a drop of almost half a point this year, as rate cuts ping the radar screen.

While that December value isn’t yet low enough to guarantee that European rates are on their way down, it does show that those who see policy on hold are losing some ground to those expecting the ECB to be bounced into chopping the cost of money.
Source: Mark Gilbert, Bloomberg

Gilbert has a reasonable summary of the issues involved, so I won’t waste time here going over them again.

As I said at the begining the really interesting consequence of any rate cut decision might be on currency values, and were a cut to happen we could see some subsequent surprises.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".