ECB is stubborn

The effect of the Dec. 19 announcement was immediate and huge — the Euro swooned more than 500 points in a few hours. We must expect the same response if and when the ECB cuts the repo rate itself, possibly at its Jan. 8 policy meeting. The market expects the ECB to ultimately cut rates to 0.50 percent, a total of 200 basis points. If the ECB were to cut by 25-bp increments, it would have many months to go to get to 0-0.25 percent, like the Fed. In fact, it would take to Sept 2010.

This seems improbable on the face of it. The ECB may be stubborn but it also values its reputation as a responsive institution, even if it values more highly its reputation for inflation fighting. So let’s assume the ECB cuts by 50-bp increments, getting to 0.025 percent or 0.50 percent by June. The expectation of these cuts is Euro-negative.

Finally, we all know by now that monetary policy alone cannot carry the weight of fixing a Great Depression II. That’s why the Fed followed the Bank of Japan and instituted a policy of “quantitative easing,” which in practice means buying just about any assets not on life-support from the banks and giving them cash. So far the banks are hoarding cash and refusing to lend it out, but Fed chairman Ben Bernanke has hope the banks will eventually find the confidence to start lending again.
The ECB has already bought much in the way of unconventional collateralized assets, ballooning its balance sheet by roughly a third, but it does not have the ability to mandate stimulative fiscal policies. Together the EU countries will be spending €200 billion, but this is independent of the ECB. Europe lacks pan-EU fiscal institutions to boost every nation across the board. The collaboration of the U.S. Fed and the U.S. Treasury, together with an activist Executive, hold out more recovery hope than Europe can dream of — probably a total of $2 or even $3 trillion. In fact, we might say the one thing the ECB lacks above all else is President-elect Barack Obama, although French President Nicolas Sarkozy has the same “whatever it takes” stance.