Konjunktur ECB Shadow Council discusses the options for the ECB

Members of the ECB Shadow Council discuss if there is reason for the ECB to take a break in the rate cutting cycle in January. Latest comment by: Charles Wyplos

Marco Annunziata - Chief Economist, Unicredit, London

The evidence accumulated since the December meeting confirms that the Eurozone has entered an extremely severe recession. PMIs, industrial production and confidence indicators keep deteriorating at a worrying pace. A similar deterioration is evident in the external environment, with a further loss of momentum in key emerging markets and no sign that the US recession is nearing a bottom. Meanwhile, HICP inflation is decelerating sharply, and is likely to turn negative for at least a few months during the summer. In these circumstances, anchoring inflation expectations around the 2% target requires further decisive monetary easing. Given the grim growth outlook and the lags with which monetary policy takes effect, such easing should be frontloaded, accompanied by a clear signal that the ECB stands ready to reverse course quickly once a recovery takes hold

Christian Bordes - Professor, Paris 1 University, Sorbonne

In October 30 ECB I suggested that the following rule, intended to ensure the effectiveness of monetary policy during this time of crisis, was to be adopted and announced : the ECB key rate will be decreased until growth expectations (as assessed by business sentiment and consumer confidence indices) are stabilised, while monitoring the concurrent evolution in inflation.

According to the most recent opinion polls, growth expectations are yet to stabilise and projections for economic activity are deeply revised downwards. Business sentiment dropped to the lowest level for more than 25 years in December while European manufacturing activity shrunk by its fastest pace on record to levels lower than initially estimated, signalling that the recession is deepening. This deepening recession curbed consumer confidence which fell to a 15-year low in November and the measure of retail sales in the Euro area remains below the limit that indicates deterioration. On the inflationary side, pricing pressures are fading throughout the Euro area with the recession and after the price of crude oil fell more than 70 percent from its July peak. Europe?s inflation rate fell to the lowest in more than two years in December, while most indicators show that inflation will continue to decrease in 2009 and that the risks to price stability in the medium term are declining (M3 money supply, which the ECB uses as a gauge of future inflation, dropped to 7.8 percent from a year earlier). According to the above interest rate rule, a situation of such gravity imposes a further decline in the key rate.


Elga Bartsch - European Chief Economist, Morgan Stanley, London

In my view, the recent sharper than expected fall in activity indicators, the greater than expected in inflationary pressure and concerns about the availability of credit to the non-financial sector warrant another 50 bp rate cut at the next meeting. I am hesitant to support a larger move after the 75 bp cut in the official refi rate at the December Governing Council meeting and the additional 50 bp cut in the deposit rate to become effective later this month. In an environment of quantitative easing, the broadening of the corridor amounts to a further stealth-easing. By the end of this month and including the rate cut I am advocating, the overnight rate will likely be 175 bp lower than it is was in early December. Looking further ahead, I am starting to wonder whether the ECB can rely on other policy-areas such as fiscal policy and financial supervision to provide adequate measures to make the low interest rate policy and the generous liquidity provisions work. My concern is the following: if very low interest rates aren?t complemented with balance sheet clean-up and consolidation, insolvent companies will be kept alive. In this case, excess capacity will not be taken out and the deflation risk won?t be reduced.

Erik Nielsen - European Chief Economist, Goldman Sachs, London

I would argue that a 100 bp rate cut to 1.5% is in order, as well as an explicit statement explaining the risks to the inflaiton outlook BOTH on the upside and downside AND how the ECB intends to address either of the two risks. My view is that the downside risk needs to be addressed by quantitative easing, which should begin now; no reason to wait.

Angel Ubide - Chief Economist, Tudor Investment Corporation, Washington DC

My view is that the economic situation is still very fragile and that, despite the recent rally in risky assets, the fragility of economy and markets is going to continue for a while and the outlook for inflation is going to continue to present downside risks. It is interesting that, for all the talk about second round effects back in mid 2008 - and the July hike justified on the basis of some second round effects occurring - there is very little, if anything, to be found. For example, Spanish wages, which were a major source of concern, will not be increased for they are indexed to the Dec yoy inflation reading - which happened to be a mere 1.5 percent. Thus interest rates need to be lowered further, because it now seems they were raised too much on the basis of second round effects that never really happened and the outlook has worsened significantly. The risk continues to be for policy not to do enough, rather than doing too much. I would like to see rates in the 1.5 percent area soon. How to get there, with two meetings in less than a month, is a bit irrelevant. Thus I would vote for a minimum of 50bp cut next week, and open for more.

Thomas Mayer - European Chief Economist, Deutsche Bank, London

With the ECB significantly behind the curve another rate cut would be warranted even without a further deterioration of incoming data. The fact that the news since the last meeting have been quite bad reinforces the case for a cut (e.g., Dec. PMIs down further; German unemployment beginning to rise in Dec .and German Nov. exports breaking down; French consumer confidence deteriorating further in Dec.). A point on the side: Many ECB watchers see the sharp drop in Nov.-Dec. headline inflation as paving the way for a Jan. rate cut, and past ECB behaviour supports this approach to ECB rate forecasting. I find this worrisome. No sensible monetary policy maker ought to base his/her policy decision on past headline inflation (especially when the latter is extremely volatile due to oil price fluctuations). Either the Council has to re-think its approach to rate decisions (if they are indeed driven to a significant extent by the last print of inflation), or it has to re-design its communication strategy (to avoid false impressions if rate decisons are really based on the inflation outlook).

Charles Wyplosz - Professor, Graduate Institute of International Studies, Geneva

All indicators point to a deepening recession and inflation has declined precipitously. Furthermore, credit crunch does not seem to be widespread in the euro area so monetary policy easing could help quite a bit.

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