ECB hints at possible rates cut

THE European Central Bank (ECB) yesterday left rates unchanged but hinted at a possible rate cut, according to IIB chief economist Austin Hughes.

He said the ECB statement was optimistic on the inflation outlook and concerned about prospects for euro area consumer spending.

Mr Hughes said the ECB still hopes stronger global growth will deliver healthier euro area activity and employment.

While the odds were still slightly against a rate cut Mr Hughes said subtle changes in ECB statement hinted rate cut remains under active consideration. The ECB left interest rates unchanged at 2%. The Bank of England also kept its benchmark interest rate unchanged at 4%.

“As usual, Mr Trichet did not expand on the ECB’s economic assessment, but reading between the lines of his formal statement to the press conference it may be possible to suggest that:

The ECB is more relaxed about the inflation outlook.

It is more concerned about the weakness of domestic demand.

These considerations mean a rate cut is possible before mid-year but the odds are still probably 2/1 against a reduction. This is because the ECB hopes a global upturn will boost Euro area activity.

While the ECB is probably very relieved about recent exchange rate developments, it is anxious not to exaggerate the role of the currency in policy setting.

“That said, it risks becoming too optimistic about its capacity to influence foreign exchange (FX) markets though verbal intervention. Mr Trichet produced much the same performance at the press conference as on previous occasions. While markets were always alert to the possibility of a gaffe from Mr Duisenberg, there is little expectation that Mr Trichet will say anything provocative or even give anything approaching an ‘open’ answer to an awkward question. In such circumstances, markets must await leaks from EU monetary sources or attempt to discern patterns in more formal official statements if they are to try and second-guess ECB intentions.

“The ECB statement saw a number of modest changes in phrasing that suggest the possibility of a rate cut is rising. There was a subtle change in the use of the word ‘favourable’ in the statement. In recent months, the ECB indicated no change in policy was appropriate as the outlook for inflation was unchanged. The statement repeated the mantra that rates are appropriate but also added inflation outlook is favourable. Admittedly, Mr Trichet also acknowledged that the outlook for inflation is in line with price stability. So, he didn’t indicate the ECB sees significant downside risks but we think it may be more important that the statement noted ‘at the current juncture, we see little upward pressure on inflation.’

“This suggests if the outlook for activity weakens, the ECB will recognise the need for an early rate cut.”