ECB Preview: What to Expect

Tomorrow the European Central Bank is expected to take interest rates to a record low of 1.00 percent. The size of their rate cut as well as the possibility of the central bank adopting “unconventional measures” should weigh heavily on the EUR/USD going into the rate decision. With the Eurozone economy deteriorating by the minute, even the traditionally stubborn ECB President Trichet may have to relent to doing more than simply reducing interest rates.

There are many different ways that the ECB rate decision could play out. Beyond cutting interest rates by 50bp, Trichet can either talk about unconventional measures vaguely or specifically. The more specific he is, the more bearish it will be for the EUR/USD. The more vague he is about alternative measures, the less bearish it will be for the EUR/USD. If he doesn’t mention it at all, then the EUR/USD could rally despite a half point rate cut.

The European Central Bank is in a difficult position. Unlike other central banks, there is no “Euro-bond” to purchase. Furthermore, according to current mandates, the ECB is prohibited from purchasing Government securities from individual nations within the Euro-zone. It is possible however for these laws to be removed, but that creates a whole new set of problems as the question then becomes more political as to which government bonds should they purchase. The fragmented nature of the Euro-zone would make it very difficult for the ECB to begin a definite purchasing plan based on the various credit ratings the countries offer. Inevitably, the brunt of neglect would be troublesome and threaten the EMU structure. In order to avoid these inherent complications, the ECB will probably opt for alternative measures which may include but are not be limited to the following:

1. Purchase International Debt
2. Create a Eurobond
3. Buy Corporate Shares
4. Buy Mortgage Debt
5. Extend the maturity of Repo Purchases
6. Exend Availability of Liquidity
7. Use Reverse Auction to Purchase Government Debt

Quantitative Easing has been a rocky road for many countries and is even more complicated for the ECB than for the Fed, BoE, or BoJ. However Trichet is running out of options and if he doesn’t act now, he could risk an even deeper recession.

Kathy Lien

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