Central Bank Outlook: ECB & BoE

ECB: October 4
Members of the ECB’s monetary policy committee find themselves in an unenviable position with political pressure on the back of a rapidly rising euro, uncertainty about the euro zone economic outlook, credit market problems and rising euro zone inflation all in the mix, when the MPC sits down to deliberate on its monthly policy statement on October 4th. The only thing that seems certain is that the ECB will leave interest rates unchanged at 4% but markets will be listening closely to what the Bank’s President – Jean Claude Trichet has to say when he gives his press conference after the rate announcement. After the last meeting in September smart money was on one more rate hike before the end of the year, probably to come in December next. The ECB may still decide to signal such a likelihood this Thursday, in its pursuit of price stability (September is the first time inflation has risen above the ECB’s 2% comfort zone since August 2006 - a 2.1% preliminary inflation rate for the month was reported last week). Despite political pressure, particularly from France, the ECB is not in a position to shape their policy around curtailing the value of the euro. The only respite that can be expected here is for Trichet to reiterate previous remarks about a strong US dollar being in the best interests of the US. It is neither his place nor that of the ECB to try to influence the value of the euro against the dollar and the forum for any action on that matter will probably rest inside the G7 group of meetings, and not with the ECB. However the other major issue that the ECB must take into consideration this week is the deterioration in euro area economic data, particularly over the past month. Unlike last month when reduced economic sentiment could have been attributed to the credit woes in financial markets, there is now growing evidence of an industrial slowdown in the euro area economy, with both manufacturing and non-manufacturing sectors in decline across all the major economic blocks of the euro zone. While expectations of an interest rate reduction at this stage are premature, economic interests in the euro area as a whole will be looking for a deliberate shift in ECB monetary policy this week. Expect the ECB to acknowledge downside risks to growth, but to make direct reference to upside risks to inflation. Also expect Trichet to avoid using the ‘vigilance’ word and the core message that markets will probably extract from this week’s policy meeting is that euro area interest rates are now likely to remain unchanged through to the end of this year. Such an outcome will likely see the euro come under pressure, though the euro will probably lose most of the ground in the days leading up to the meeting.

BoE: October 4
Many analysts see the possibility of rate cute from the Bank of England this week, with the probability currently around 40%. The Bank’s Governor has a major credibility issue hanging over him going into this week’s MPC, following the fiasco of the public run on the Northern Bank early last month and the BoE’s u-turn on providing supportive financing during the credit crisis. The BoE also got their inflation forecasts completely wrong this summer and with inflation easing to an annualised 1.8% in August and the housing sector starting to cool, the Bank may feel obliged to start cutting rates sooner rather than later. As the MPC’s chief hawk and policy spinner, Governor King must shoulder most of the blame for having completely miscued on the economy’s inflation risk and unless the BoE ease rates quickly the wider economy may start to slow sharply, following 5 interest rates rises since August 2006. With ample evidence of a global slowdown and downside risks to UK economic growth, there appears no logical reason for the BoE to hold off on a rate cut until later in the year. In addition, the Bank does not know the real impact of the credit crisis on the UK banking sector and it is best to err on the side of caution. They should act this week. Some of the more rational and dovish voices on the Committee are sure to push for a cut at Thursday’s vote and should they succeed, it could spell more trouble for Governor King in his position at the helm of the Bank of England. I see the chances of an easing this week at 50%. A rate cut would see a rapid demise of the pound, while even if the Committee stand pat, sterling may still come under pressure as markets are likely to price in a cut for later in the year.

Ted Bearstruck
2nd October 2007