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Inflation forecast
GDP forecast
Source: Handelsbanken Capital Markets, Reuters Ecowin
Note: Scenario with unchanged oil price assumes USD 50 per barrel. EUR/USD at 1.33 is assumed in both scenarios.
Short-term interest
rates are already
extremely low
ECB rate cuts coming to an end – other measures are to be expected
The ECB has so far cut its refinancing rate by 300bp since the collapse of Lehman Brothers
in mid-September, to a record low of 1.25 percent. ECB President Jean-Claude Trichet recently
signalled that another “moderate” rate cut of 25bp should be expected in May. Why
not bring rates lower, as the Federal Reserve and the Bank of England have done? Firstly,
effective short-term interest rates are already extremely low, with O/N rates at 94bp, and
are bound to fall further as the ECB delivers in May. This is comparable to O/N rates
(60bp) in the UK, where the BOE has brought the Bank Rate to 0.50 percent. Secondly,
ECB officials, such as Gonzalez Paramo, argue that “[e]xcessively low rates reduce incentives
for everyone, especially the most indebted, to restructure their finances.” We have
difficulty finding faults with these two arguments, even though rising deflation risks may
trigger a further rate cut down the line should the need arise.
Officials are also laying the groundwork for introducing further measures to improve the
availability of financing. According to the ECB’s Weber, the ECB should concentrate on
the banking sector rather than capital markets. It is likely that it will start lending cash up to
one year (from six months currently).
With a record output gap that will continue to grow during 2009 and several years of declining
core inflation and rising risks of deflation as a result, we have difficulty seeing why
the ECB should hike rates in the next couple of years. Excessive credit growth is unlikely
to materialise anytime soon given the enormous losses facing the financial sector on the
back of surging default rates. What’s more, credit demand is likely to be suppressed given
the lacklustre investment demand forecast for 2009 and 2010. We therefore expect the ECB
to start normalising rates in 2011 at the earliest.
Martin Enlund, +46 8 463 4633, maen12@handelsbanken.se
14 April 28, 2009