ECB Meeting: Rate Cut Discussed‏

The ECB president, Mario Draghi, surprised by announcing that a rate cut was discussed at this month's ECB meeting. The Governing Council had a wide discussion on rates but the council decided to keep all rates unchanged. It 'briefly touched upon the complexities (of negative) rates but didnt elaborate further'.

This could be an early signal of a January 2013 rate cut, and the likelihood of this scenario has increased significantly. However, if the Governing Council had decided to signal a rate cut, Draghi would probably have sent fewer mixed signals. Draghi emphasised the very accommodative monetary policy and improvements in leading indicators and financial market sentiment.

Will we get a policy rate cut? It is a very close call but it will depend on how quickly data improves. We expect a moderate improvement in the leading indicators going forward. A rate cut will be partly priced in for the next couple of meetings and data releases will be scanned for signs of an improvement/worsening over the next months.

The Eurosystem staff macroeconomic projections for the euro area were revised significantly down. The staff now forecasts GDP growth in the range of -0.6% to -0.4% for 2012, -0.9% to 0.3% for 2013 and 0.2% to 2.2% for 2014. The 2013 projection is more pessimistic than consensus, the IMF and European Commission.

The ECB staff forecast for inflation of 2.5% for 2012, between 1.1% and 2.1% for 2013 and 0.6% to 2.2% for 2014, highlights that the inflation outlook is not hindering further ECB easing. Both the inflation and growth forecasts are on the low side compared with our expectations.

Despite today’s signal, our main scenario is still that the ECB will keep rates unchanged for some time to come, with risk clearly tilted towards a cut in both the refi and deposit rates. We expect that signs of economic improvement in the coming months will keep the ECB from cutting rates but it will be a close call.

The market reaction reflect the increased likelihood of rate cuts. The yield curve moved lower following the announcement and EUR/USD weakened.

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