ECB Preview: What Traders Can Expect
04/02/2009 11:26 am EST
Today, the European Central Bank is expected to take interest rates to a record low of 1.00%. 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 euro zone economy deteriorating by the minute, even 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 they should 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. Purchasing international debt
2. Creating a euro bond
3. Buying corporate shares
4. Buying mortgage debt
5. Extending the maturity of repo purchases
6. Extending availability of liquidity
7. Using reverse auctions 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.
By Kathy Lien, Director of Currency Research at GFTForex.com