3 Reasons Why the ECB Will Hold Its Ground

Tomorrow at 11:45 a.m. GMT, the European Central Bank (ECB) will be making its interest rate decision. In a rather unusual twist, a survey indicated that ALL 57 economists who participated predict that the central bank will be leaving rates steady at 1.00%.

You probably have a higher chance of hitting a number in roulette than having a unanimous prediction by a group of economists! What gives?!

Here are three reasons why all those economists probably think the ECB won’t be making any changes:

1. It has done all it can already.

For one, the ECB has already injected over one trillion euros into the financial system over the past few months.

The ECB feels that it is now up to local governments and commercial banks to do their part. Policymakers are pushing for harder, stricter austerity measures and the implementation of structural reforms that should lead to more stable economies and job generation.

Meanwhile, the ECB has been getting on the case of commercial banks to double their recapitalization efforts and let liquidity flow into the markets. What’s the use of dumping loads of cash if it isn’t ending up in the hands of everyday Francois’s and Jose’s?

2. Persistently high inflation.

High inflation persists in the euro zone, as the sanctions on Iran have helped push oil prices higher. The latest CPI figures showed that inflation remained at 2.6% in March, well above the central bank’s 2% target for 2012.

In the past, the ECB has countered rising inflation by hiking interest rates. However, thanks to the growing concern that surrounded the debt crisis, the ECB eventually reversed its course and lowered rates.

Given the current state of European economies, rising oil prices could reduce the purchasing power of consumers. Everyday consumers will be forced to use their discretionary income on gas instead and this could drive down overall demand.

That being the case, the ECB might be better off keeping rates low rather than increasing them, in order to boost demand and keep the economy afloat.

3. Recent data hasn’t been great, but it hasn’t been bad enough to call for a rate hike either.

If you’ve been tracking the euro zone’s economic performance (it’s just like tracking stats for your fantasy NBA team, man!), then you’re probably aware that the economy hasn’t been performing all too well in recent weeks.

Since the last ECB meeting on March 8, manufacturing and services output have fallen strongly. March recorded the worst performance so far this year as the euro zone PMI composite output index fell from 49.3 in February to a three-month low of 48.7. Furthermore, the unemployment rate hit a fresh high as it rose from 10.7% to 10.8%.

But the euro zone did have some things to cheer about over the past month. For instance, economic sentiment picked up on signs of the sovereign debt crisis easing. The German ZEW economic sentiment surged from 5.4 to 22.3 in March, while the euro zone version of the index leapt from -8.1 to 11.0.

Over all, I would say that recent reports have been on the weak side in the euro zone, but I don’t think it’s enough to warrant a rate hike just yet, especially if you consider the positive results we saw the previous month.

So if it’s unlikely that the ECB will make any changes to interest rates, what should we be on the lookout for?

In my opinion, y’all should listen carefully to ECB President Mario Draghi‘s press conference and try to decipher clues as to whether the central bank will start making preparations for its exit strategy.

Will the ECB start rolling back the one trillion EUR of cheap loans that it has injected into the markets since December of last year? Maybe, maybe not! Rumor has it that the central bank is still divided on the issue.

Bundesbank President Jens Weidmann has been calling for the ECB to start drawing up an exit strategy, and he hasn’t been alone in his shouting either! Benoi Coeure, an ECB senior official, has also been campaigning for a “return to a less accommodative stance.” On the flip side, those that disagree with Weidmann’s camp believe that it’s way too early for the ECB to even consider exiting its crisis measures.

EUR/USD Chart

Right now, I think the only thing that we can be certain of is that there’s still a lot of uncertainty and division surrounding the outlook for the ECB’s monetary policy. But words that indicate a more unified direction for the central bank could serve as a catalyst for EUR/USD to finally break out of its range.

Stay sharp, kids! Things could get messy!

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