After eight years of heading the ECB, Jean-Claude Trichet is ready to hang his Armani suit for a polo shirt and khaki shorts to sail the Caribbean. On October 31, 2011, he will officially turn over his position to Mario Draghi as the leader of the central bank.
So what did the always calm and collected Trichet say in his last statement as the head honcho of the ECB?
A few market participants were expecting Trichet to leave with a bang by announcing a rate cut. However, he fell short of the euro bears’ expectations when he said that the 23-member council of the bank decided to keep interest rates steady at 1.50%.
The statement came as a surprise to some investors. After all, there’s still so much drama surrounding the European debt crisis with policymakers talking about recapitalizing banks. Also, if you’ve been reading up on my good man Pip Diddy‘s commentaries, you probably know that there have been ample signs of slowing economic growth in the euro zone.
Heck, even the ECB itself doesn’t seem to have its hopes up for the economy as it revised its growth forecasts for the region. In September, the bank said that it expects growth by the end of 2011 to come in at 1.6% after previously stating that it would print at 1.9%. As for 2012, the GDP forecast was revised down to 1.3% from 1.7%.
However, we have to remember that the central bank’s mandate is to maintain price stability. Trichet said that inflation would most probably stay above the bank’s target limit of 2% until the year ends. September’s CPI showed the fastest acceleration in inflation in almost three years to 3.0% from 2.5% in August. The figure might have been enough for policymakers to stop short of cutting rates.
Because it’s no secret that Greece is still in danger of defaulting, the ECB was also under pressure to present a plan to support the banking sector. Trichet reported that the central bank would offer unlimited 12-month loans to banks by the end of the month and unlimited 13-month loans in December. The ECB has already pulled off this strategy in 2009 when the financial crisis made banks too scared to lend to each other.
On top of that, the bank will also buy 40 billion EUR worth of covered bonds. A lot of investors think that covered bonds are super duper safe assets since they are funded by mortgages and public sector loans. Through these measures, the ECB hopes to encourage lending and prop up liquidity in the banking sector.
And it seems like investors were impressed with the ECB’s proposals! Looking at the charts, we see that after EUR/USD dipped a little to 1.3250 following the bank’s interest rate decision and press conference, it rallied 200 pips to its intraday high of 1.3450.
Does this mean it’s time to go loco buying euros? Err, I’m not too sure about that.
In this humble old man’s opinion, I wouldn’t get too excited about going long on the euro just yet. It doesn’t take a rocket scientist to infer from Trichet’s statement that the ECB is very worried about the economy. Aside from that, the market rumor is that there were a lot of members of the ECB council who voted for a rate cut. So don’t rule out its possibility just yet!
If we don’t hear positive news about the sovereign crisis or if economic data from the euro zone continue to disappoint, we may just see the central bank slash borrowing costs. The only difference is, when that happens, the decision won’t be delivered with that heavy French accent we’ve become familiar with.