For the ECB, It's Good to Have Options

09/09/2011 9:39 am EST

Focus: GLOBAL

Jim Jubak

Founder and Editor, JubakPicks.com

As expected, the European Central Bank kept its benchmark interest rate at 1.5% today, September 8.

But outgoing bank president Jean-Claude Trichet was unexpectedly vocal about weaknesses in the Eurozone economy, and the range of options open to the bank if the crisis worsened.

Trichet told a press conference in Frankfurt that the European economy faces "particularly high uncertainty and intensified downside risks." The central bank, he said, stands ready to add liquidity to the financial markets if necessary.

The bank cut its forecast for 2011 Eurozone economic growth to 1.6% (from 1.9%), and for 2012 to 1.3% (from 1.7%). The euro dropped below $1.40 on the news. The currency is now down 4% against the US dollar for 2011.

The yield on ten-year German bunds fell to a record low of 1.823%, as some bond traders speculated that Trichet had indicated a pending interest rate cut. I think that's an over-reaction to his remarks. Economic growth in Europe would have to show further signs of weakening in the core economies of France and Germany before the bank would actually reverse course on interest rates, in my opinion.

After all, the bank had just begun to raise rates this spring, and reversing course after two rate increases-criticized by many at the time as too soon, given continuing economic weakness and the persistent euro debt crisis-would deliver another hit to the central bank's credibility. And right now, the bank doesn't have a whole lot of extra credibility that it can afford to spend.

Trichet's comments do give maneuvering room to his successor, Mario Draghi. In the run up to his term that begins in November, Draghi has been talking tough on the debt crisis and how long the bank might continue to buy Spanish and Italian bonds to support prices.

Trichet's remarks on the worsening state of Eurozone economies and the euro crisis give Draghi an opening to loosen monetary policy without seeming like he has abandoned his convictions by pointing to those changed conditions.

Rather than a signal of what the European Central Bank has decided to do, I see today's remarks as evidence that the bank is uncertain about what steps to take, but that it sees room to maneuver as extremely valuable right now.

Full disclosure: I don’t own shares of any stock mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did not own positions in any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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