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European Central Bank way too cautious

November 6th, 2008 · No Comments

England once again takes the lead in Europe by cutting interest rates by a quite unprecedented 1.5% (to 3%). We feel that Trichet, the head of the European Central Bank (ECB) should have followed. Instead, the ECB cut interest rates by just half of a percent (to 3.25%). It’s falling behind the curve, inflation really isn’t any problem right now, instead we have serious growth problems that need drastic measures.

We can only think of one argument why central banks should think twice about drastic cuts in interest rates, and that is to avoid inflating another bubble and so reinforcing the bubble cycle and the moral hazard problem.

The first points to a phenomenon that super loose monetary policy to fight the pricking of the previous bubble sets up the conditions for the next one through easy money, and the moral hazard problem is people getting used to get a bail-out if their risky bets go sour, decreasing incentives not to do that again.

However, we think the conditions are so difficult, that these kind of considerations really should move to the background right now. The urgent problem is to keep the economy from falling into a deep funk, which could very well reactivate the financial sector problems from which we just seem to have escaped (by the narrowest of margins).

Trichet Says Can’t Rule Out More Cuts as Growth Slows (Update1)
By Christian Vits

  • Nov. 6 (Bloomberg) — European Central Bank President Jean- Claude Trichet said he can’t rule out a further reduction in interest rates after today’s half-point cut because the global financial crisis may lead to an extended economic slump.
  • “The intensification and broadening of the financial turmoil is likely to dampen global and euro-area demand for a rather protracted period,” Trichet said after reducing the bank’s key lending rate to 3.25 percent, the second cut in less than a month. “Price, cost and wage pressures should also moderate. I don’t exclude that we will decrease rates again.”
  • Central banks around the world are paring borrowing costs as the financial turmoil curbs growth. The Bank of England today unexpectedly lowered its key rate by a third to 3 percent and the Swiss central bank followed with an emergency half-point cut. The euro region’s economy is probably already in a recession and will stagnate in 2009, the European Commission said this week.
  • Economists predict the bank will continue to reduce borrowing costs at the most aggressive pace in its 10-year history, taking its key rate to 2.5 percent by April.
  • The ECB is coming from this very hawkish tone just one and half months ago and it would have damaged their reputation if they did more than the 50 basis points,” Carsten Brzeski, an economist at ING Group in Brussels, said before Trichet spoke. “But ultimately, they will follow.”
  • Deeper Cut Considered
  • Trichet said the ECB’s rate-setting Governing Council also discussed a 75-basis-point reduction.
  • Inflation slowed to 3.2 percent in October after reaching a 16-year high of 4 percent in July. The ECB aims to keep the rate below 2 percent. Oil prices have more than halved from a peak of $147 a barrel and inflation expectations have stabilized.
  • Part of “the important sentiment we have” is not only that inflation risks are diminishing, “there’s also been a regaining of the control of inflation expectations.”
  • Economic growth in the euro area will slump to just 0.1 percent next year, the worst performance since 1993, the Brussels- based European Commission forecast on Nov. 3. It said the economy, which contracted in the three months through June, will probably continue to shrink in the third and fourth quarters.
  • The International Monetary Fund today predicted economic contractions in the euro region, the U.S. and Japan next year. “Global action to support financial markets and provide further fiscal stimulus and monetary easing can help limit the decline in world growth,” the IMF said.
  • Manufacturing orders in Germany, Europe’s largest economy, dropped by a record 8 percent in September, the government said today.

It really is ugly out there, we need further rate cuts (while financial markets are still working) a.s.o.p..

Tags: Credit Crisis