Recession fuels so the prospect of further rate declines

To the urgency of the economic situation, the European Central Bank (ECB) has given its most important monetary boost in its history. The Board of Governors, gathered exceptionally in Brussels yesterday, decided to reduce the main rate by 75 basis points to 2.5. A minority of economists had relied on an equally important gesture, others having provided rather decreased by 50 basis points. But once again, the proposal institution has been more conservative than its European counterparts: the Swedish Central Bank shocked markets with a gesture of 175 basis points, while the Bank of England lowered its rate to 100 basis points.

"A number of risks to growth that were identified are materialized", recognized Jean-Claude Trichet, who now judge inflationary pressures "balanced". The President of the ECB observes a "private sector loans continued moderation", but not a "drying" of credit. "We see the weakness of the economy and the weakness of consumption last for a few quarters", he added. This finding is reflected in the new growth forecasts of the ECB, which has finally admitted that the economy of the euro area would be in a recession next year. GDP should withdraw from 0.5 in 2009, while the previous projection, established in September, reported an increase of 1.2. For 2010, growth would recover to 1. "A resumption could intervene progressively, supported by the fall of the price of raw materials and an easing of the financial tensions", forward Jean-Claude Trichet. The inflation forecast has also revised downward: it should fall to 1.4 in 2009 and then back to 1.8 in 2010, under the effect of a rebound expected contents first in the second half. The ECB therefore excludes the moment a scenario of deflation.

Recession fuels so the prospect of further rate declines. But Jean-Claude Trichet did not say explicitly as it did last month. He also refused to say that the decision of the Board of Governors yesterday had been unanimous, sign that there are differences between national central bankers.

Real economy

Before the monetary easing, the ECB may decide to tackle the difficulties of the interbank market to restore the transmission mechanism of the lower rates in the real economy. Asked about the possibility of the Institute of issue redeem directly assets, Jean-Claude Trichet said: "I think that it is possible." And add: "It is important to ensure that the lower rates will be effective by passing through various channels to the real economy." Without giving any indication on the expiry of a further decline, he was reluctant to bring rates to extremely low levels. "We must be careful to not be trapped to nominal levels that would be too low."

Jacques Cailloux, Economist at RBS, these comments are a sign that the ECB could wait the month of February to continue lowering rates. "But the level of weakness in the economy should prevent it to delay its decision," he says. So, the scenario of a drop of 50 points of base in January is the most likely by him. The European main rate would then reach 2, its lowest level ever reached.