Many in the euro zone would be happy seeing this Barclays forecast becoming true, not the least in its peripheral shores.
“We have revised our ECB projection and look for the ECB to lower the main policy rate by 25bp at its meeting on 6 October, and to widen the interest rate ‘corridor’ back to +/-100bp, which would entail lowering the deposit facility rate by 50bp to 0.25%. In turn, this would provide scope for the EONIA (overnight) rate to trade significantly lower, given the presence of excess bank reserves.”
At Barclays, this has been a hint that they’ve had for a while, but what now makes it more propitious isn’t necessarily a kinder attitud towards the (really) struggling members of the monetary union. Unfortunately,
“the risk of a hard restructuring of Greece has increased, in our view, even despite the latest news. As well, since then, the tensions within the euro area have escalated, particularly for some banking systems, suggesting a greater need for stimulus.
“In our previous ECB Watching article, we noted the significant shift in ECB language at its 8 September meeting. Moreover, in the interview published with Expansion today, ECB President Trichet emphasised this shift in language, which we find telling (see Trichet interview in Expansion stresses ECB’s shift of stance concerning outlook for growth , 20 September 2011). The ECB has called for and won new commitments by governments, particularly in Italy and Spain, to engage in greater fiscal consolidation and structural reform. As well, our projection would be based upon Greece satisfying the “troika” (thus opening the way for the next disbursement), as well as the major parliaments ratifying the EFSF enhancements.
“Meanwhile, with the first ever attendance of a US Treasury Secretary at last weekend’s Ecofin meeting, it is clear that international pressure on the EU authorities to provide greater aggregate support is likely to be intense. The ECB might well expect to come under further pressure at the forthcoming IMF and G7 meetings, particularly if the Fed undertakes some further easing steps.
“In our view, the issue of the ECB presidency transition also could be a factor (even though officials are likely to deny it). The transition is coming at an extremely challenging time in the euro’s history. Based on the indirect implications of his comments, Mr Trichet could be seen to be preparing the ground for a rate cut – yet the October meeting will be the last scheduled policy meeting that he chairs.
Would Mr Trichet wish to prepare the ground for his successor, Mr Draghi, to cut rates?
“In our view, if Mr Trichet presided over a small rate cut, then this would help to foster a smooth transition. Under such a scenario, Mr Draghi would then have a couple of options: if conditions deteriorated significantly further, he could continue the easing. However, if the economy and financial tensions were to turn around, then he would have the option to re-commence on a tightening cycle. Either way, by cutting interest rates before leaving office, Mr Trichet would hand over a favourable situation: Mr Draghi would not be coming into office and have to undertake the first step in an easing cycle (a move that could attract major scrutiny and potential criticism in the German media). In other words, by presiding over a rate cut, Mr Trichet would be taking a small risk with his estimable stock of capital, in the interest of continuity for the euro area.
“Therefore, our view is that the ECB will decide to do something on 6 October. The most likely outcome, in our view, would be a widening of the interest rate corridor (ie, this would be a closet rate cut, helping EONIA to move lower and be significant for the markets and therefore for the economy, but without needing to lower the main policy rate). As well, a wider corridor could help encourage bank intermediation. However, in our revised baseline scenario, we would look also – albeit with somewhat less confidence – for the main policy rate to be lowered by 25bp, to provide some modest additional stimulus into the beleaguered economy (particularly amid an international environment of measures to inject further stimulus to support global demand). If our projected 25bp main policy rate cut does not materialise on 6 October, it could still come at a later stage, such as on 8 December when the next set of Eurosystem staff projections are published.”
In Barclays’ opinion, the ECB’s 2013 HICP inflation projection is likely to be about 1.5%, given the weak perspective the ECB has on GDP expansion in 2012,
“therefore, on a forward-looking, risk-insurance basis, the ECB could justify a rate cut. As well, the money, credit and wage data do not stand in the way of an easing, in our view.”
Barclays, anyway, doesn’t want to get told it was wrong all along, and since EU institutions move in so confusing directions,
“it should be noted that other options also remain available for the Governing Council, such as a resumption of the covered bond purchase programme and the launch of additional term re-financings (in either six or even in twelve months). As well, the Council still has the option of purchasing sovereign debt aggressively, but this particular course of action has been proving deeply divisive on the Council and, thus, is a last resort option.
Going forward, our profile is for the main policy rate to remain at 1.25% (and the deposit rate facility at 0.25%) until policy begins to adjust higher sometime, probably during H2, in 2013. That said, if economic conditions continue to deteriorate and therefore result in a recession, then we would expect a further cut in the policy rate to be implemented. There is clearly not so much room for monetary easing in the form of interest rate cuts in this environment, given the low level. Nonetheless, at a time when the euro area is plainly in a crisis, which has scope to shake the euro to its core, we consider that non-regular measures aimed at alleviating and ultimately resolving these acute challenges will be required from all sides, including the ECB.”