16 January 2001, 15:26 OUTLOOK: ECB to leave rates steady Thursday; rate cut expectations overdone
--- by STEVE WHITEHOUSE ---
PARIS (AFX) - The European Central Bank will leave leading interest
rates unchanged at Thursday's governing council meeting, economists
said.
Market expectations of an early rate cut have been greatly overdone
and it is likely to be some time before the ECB contemplates an easing
move, they said.
Euribor futures prices point to market expectations that the ECB
will lower the minimum bid rate on its main refinancing rate by 0.75
points by the summer, from the current 4.75 pct level.
Such rate cut expectations have been fuelled by the U.S. Federal
Reserve's Jan 3 easing move, the euro's recovery, oil price declines
and a moderation in M3 growth.
But economists said markets are misreading the ECB's intentions.
"There will be no change. Everything has been blown out of
proportion at the moment," said Ulla Kochwasser of Industrial Bank of
Japan, who expects rates to be left unchanged throughout 2001.
"Market expectations of a euro area cut as early as this quarter
appear premature," said Jean-Francois Mercier and Carmen Nuzzo of
Schroder Salomon Smith Barney.
Of 37 economists polled last week by AFX News and Agence
France-Presse, all said they expect the minimum bid rate to be left at
4.75 pct on Thursday, and only seven predicted an easing move before
the end of the first quarter.
The ECB is clearly not overly worried about the impact of the U.S.
economic slowdown on euro zone growth and therefore it is wrong to
assume that it will simply follow the Fed lower, economists said.
In its January monthly bulletin last week, the ECB spoke of "a
picture of continuing robust, albeit slightly lower, growth rates".
And chief economist Otmar Issing said the euro zone economy will
remain at a high level of growth, with U.S. interest rate changes not
immediately affecting the ECB's interest rate policy.
"As long as the ECB remains convinced that the slowdown in the U.S.
will have little impact on the euro area economy, the upward risks to
prices will probably continue to dominate over the downward risks,"
said Michael Schubert of Commerzbank.
Moreover, the ECB will not want to undermine the euro's recent
recovery against the dollar, and will want to see further euro gains to
help boost public confidence in the currency ahead of the Jan 2002
introduction of euro notes and coins. Such gains are only likely if the
gap between U.S. and euro zone interest rates narrows further,
economists said.
"It may well prove difficult for the currency to strengthen if the
ECB is inclined to follow the Fed's lead on interest rates," said
Schubert.
"The euro has certainly appreciated significantly since the end of
November, but the ECB wants to consolidate this gain, particularly
ahead of the introduction of euro notes and coins," said Emmanuel Ferry
of Exane.
The Fed's Jan 3 cut reduced the gap between its Fed funds target
and the ECB minimum bid rate to 125 basis points, but this differential
is likely to narrow further, economists said.
A further cut in the Fed funds rate, currently at 6 pct, is widely
expected at the Jan 30-31 Federal Open Market Committee meeting, and
the ECB will only consider lowering its own rates by a limited amount
well after any further Fed easing, economists said.
"Once the Fed has reduced to a level of 5.5 pct, which would be
expected by next summer...then the ECB will be able to lower its refi
rate by 25 basis points without compromising the value of the euro,"
said Marc Touati of Natexis Banques Populaires.
Even CSFB, which expects the Fed funds rate to be cut by a further
100 basis points to 5 pct by mid-year, said it only expects the ECB to
trim 50 basis points from the minimum bid rate in two steps starting in
the second quarter.
The ECB does not need to be in any rush to ease credit because its
current rates are still relatively accommodative, economists said.
"Even after the recent Fed 50 basis point cut, monetary conditions
are relatively tight in the U.S., while remaining accommodative in the
euro area," said Mercier and Nuzzo.
Belgian National Bank governor Guy Quaden this week suggested that
this also remains the ECB's view, noting that ECB rates "cannot
currently be regarded as damaging economic growth".
Some observers detected a shift in the ECB's message in the January
monthly bulletin, in which it highlighted the prospects for lower
inflation in the months ahead.
But economists said any shift was one towards neutral from the more
hawkish message of December, rather than any signalling of early rate
cuts.
"We reckon the ECB signalled another small step in the direction of
a balanced assessment -- there was probably still a tightening bias in
December -- but no intention to ease," said Lorenzo Codogno of Bank of
America.
In the bulletin, the ECB insisted that there are "still elements of
upward risks to price stability which warrant close monitoring",
focusing particularly on the possibility of inflationary wage rises and
the need for tax cuts to be matched by reductions in government
spending.
"The ECB thinks that there are enough price risks to the upside not
to cut rates for the moment, primarily from the wage side. There is
also the boost to come from fiscal reforms in Europe," said Kelly
Tonkin of Lehman Brothers.
Ferry of Exane said the inflationary effects of tax cuts in
particular will deter the ECB from lowering rates.
"The policy mix is expansionist. Governments have introduced
massive tax cut programmes, often in a pre-electoral context. The ECB
will feel obliged to compensate for this pro-cyclical trend by a more
restrictive posture on the monetary side," he said.
Moreover, although inflation is expected to fall, it is currently
well above the ECB's 2.0 pct price stability ceiling, reaching 2.9 pct
in November. Cutting rates with inflation above the central bank's own
tolerance threshold would send out the wrong signals, economists said.
Most economists -- 28 of the 37 polled by AFX and AFP -- do expect
the ECB to cut rates at some stage, but the bulk of these do not expect
the easing move to come until the second quarter and some only see a
rate cut later in the year.
"The ECB will not start to ease until the third quarter, or even
the fourth quarter. Our central scenario is for a first move of 25
basis points only in September. By that time the Fed will probably have
lowered its target rate by at least 100 basis points," said Ferry.
And ECB rate cuts are expected to be limited in scale.
"There is no reason to increase rates, but nor is there really any
reason to cut aggressively. With the U.S. economy slowing, the next
move could be a cut in the second quarter, particularly if the euro
continues to appreciate, but there will not be much more movement in
rates after that," said Philippe Weber of CPR.
A minority of economists do see scope for aggressive rate cuts.
Eckhard Schulte of Dresdner Kleinwort Benson predicts that the refi
rate will be cut to 3.75 pct by the summer, noting: "If the Fed cuts
rates once more and the world economy stalls then the pressure on the
ECB will be huge."
But there is also a sizeable minority which expects no cut in rates
at all. Eight of the 37 economists in the AFX/AFP poll said rates will
be left unchanged throughout 2001 and one forecast that rates will
actually be raised towards the end of the year.
"We would not be surprised by some softness in the ECB's statements
during the second quarter, but no actual cut is on the cards yet," said
Sirpa Wallius of Merita Bank.
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