ECB Will Again Do Nothing

Thursday, May 07, 2009

The European Central Bank (ECB) is most likely to leave its leading overnight interest rate unchanged at 1.25% at its council meeting later today. While there have been lots of soundbites from various eurozone CB governors in the last two weeks, forcing ECB president Jean-Claude Trichet to publicly gag them a few days ago, I expect that the hawks will prevail at this meeting.
Recent inflation data has been tame, but the deflation in wholesale prices is better attributed to the fast and huge decrease in consumer demand than to a structurally improved picture.
My personal mini survey that spans friends in 4 eurozone countries - the Federal Reserve would call it anecdotal evidence - shows that both business investments and personal consumption are delayed to an uncertain point in the future as prudence is the driving force nowadays. Nobody goes shopping when the general economic outlook is dark grey at best. This recession has only begun and will last longer than officials ready to admit. Shoot me with a paintball gun with the colour of your choice if I am wrong and the economy improves in 2010. IMHO a short growth surge may be possible, but will turn out to be a straw fire originating in deficit spending loved so much by politicians who were asleep at the wheel since the onset of the crisis in August 2007.
The ECB is well advised to leave rates unchanged in order to keep its left powder dry. This downturn has still a lot of room.
Slight economic improvements in Germany root in the current state premium of €2,500 that is given to all inhabitants who drive their decade old cars to the shredder and buy a new one at the same time. This will only be a flash in the pan and one can expect another nosedive in German consumer demand after this stimulus ends.
While the ECB does not follow any exchange rate goals officially, it certainly watches the exchange rate for Federal Reserve Notes. A rate of $1.30 to $1.35 is quite comfortable at this time, creating a welcome equilibrium between the two major currencies which both have lost out against gold in this millennium.
A wave of rating downgradings for Eurozone banks might underscore that banks on both sides of the Atlantic are in the weakest position of the last seven decades.
Expect the ECB statement to repeat the known issues of the past. Trichet will once again plead for moderation in wage increases and ask for structural fiscal improvements. That is certainly a good old idea but Eurozone politicians shy away from any measure that would add to the current burden of consumers who are engulfed in debt up to their eyeballs.


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