A Forex View From Afar

ECB Press Conference Analysis

• The Governing Council decided to reduce the key ECB interest rates by a further 75 basis points
• Since September there had been an intensification and broadening of the financial market turmoil
• Tensions have increasingly spilled over from the financial sector to the real economy
• Downside risks to economic activity that were identified previously have materialized
• Global economic weakness and very sluggish domestic demand persisting in the next few quarters
• The economic outlook remains surrounded by an exceptionally high degree of uncertainty
• It is of the utmost importance to maintain discipline and a medium-term perspective in macroeconomic policy-making
• Annual HICP inflation has declined substantially since July
• The significant decline in headline inflation since the summer mainly reflects the considerable easing in global commodity prices over the past few months
• Lower commodity prices and weakening demand lead us [ECB] to conclude that inflationary pressures are diminishing further
• The annual HICP inflation rate is expected to continue to decline in the coming months and to be in line with price stability over the policy-relevant horizon.
• A faster decline in HICP inflation cannot be excluded around the middle of next year, mainly due to base effects. However, also due to base effects, inflation rates could increase again in the second half of the year
• Unexpected further declines in commodity prices could put downward pressure on inflation
• Underlying broad money growth point to a sustained but moderating rate of monetary expansion in the euro area
• The intensification of the financial market turmoil since mid-September marks a potential watershed in the evolution of monetary developments. The most recent money and credit data indicate that this intensification has had a significant impact on the behavior of market participants
• For the euro area as a whole, there were no significant indications of a drying up in the availability of loans
• The underlying pace of monetary expansion has remained strong, bus has continued to decelerate further.
• The level of uncertainty remains exceptionally high
• The Governing Council will continue to keep inflation expectations firmly anchored in line with its medium-term objective
• The Governing Council considers it crucial that discipline and a medium-term perspective are maintained, taking fully into account the consequences of any shorter-term action on fiscal sustainability.

ECB Staff Projections

The ECB Staff Projections had been downgraded significantly from the latest report, published in September. Euro system staff project sees the annual real GDP growth between 0.8% and 1.2% for 2008, between -1.0% and 0.0% for 2009, and between 0.5% and 1.5% for 2010.

The initial GDP projections in September were standing between 1.1% and 1.7% in 2008 and between 0.6% and 1.8% in 2009. Throughout the December projection, the ECB asses the Euro-area will be in a full blown recession in 2009. This is quite a large swing, since earlier this year growth was seen to pick up in 2009.

Referring to inflation, the Euro system staff projections foresee annual HICP inflation of between 3.2% and 3.4% for 2008 and declining to between 1.1% and 1.7% for 2009. For 2010, HICP inflation is projected to lie between 1.5% and 2.1%.

Projections for the CPI read were standing in September between 3.4% and 3.6% in 2008 and between 2.3% and 2.9%. Even thought the initial numbers were rived much lower for 2009, the ECB does not foresee inflation “undershooting” its target, as the BoE does. Furthermore, the large downward inflation revision can also be charge to the strong declines seen in the commodity markets since September, mainly in the crude’s price.

Analysis

Mr. Trichet put a lot of empathy on the high uncertainty surrounding the financial market and even noticing a change in the market’s behavior. Even though it was not clearly specified which was, Mr. Trichet was probably referring to the market’s risk-aversion.

Overall, the press conference did not bring any surprises, however, Mr. Trichet seemed unwilling to discuss if the Governing Council members had any other alternative than the 75 basis points rate cut. Most likely, opinions diverge during the interest rate meeting, but the Council takes its decisions “unanimously” and “the Council is never pre-committed”. This was the first time when Mr. Trichet refused to talk about the options the central bank had.

Asked if the ECB sees the Euro-area fighting deflation in the coming quarters, Mr. Trichet insisted that the Euro-area is experiencing disinflation (a decrease in the rate of inflation), rather than deflation (negative inflation rate). Also, Mr. Trichet said the ECB is not implementing a quantitative easing policy, but the ECB’s balance sheet had expanded at a strong pace because the bank accepts any bid at a fixed rate. Before the credit crunch, the ECB had auction style open market operations.

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