The Bank of England and the European Central Bank meet tomorrow. A strong case can be made that the economic conditions and outlook warrant additional monetary easing.
After the UK economy contracted for three consecutive quarters, it may have stagnated in Q3. It has reached a sub-optimal equilibrium. Price pressures have eased considerably. The pace of increase in consumer prices has been halved from 5.2% in September 2011 to about 2.5%.
The BOE is already engaged in QE, which will be completed next month. It could announce an extension of its purchases and minimize the uncertainty among investors. However, this does not seem to be an important consideration for policy makers. The BOE is likely to wait until next month to make the announcement, giving itself more time to assess the domestic economy, as well as the global headwinds.
The base rate is set at 50 bp. BOE officials do not see much merit in cutting the rate at this juncture. Instead, and with some limited success, it is providing cheaper financing for new lending. One must respect the fact that when the Bank of England does not do anything it does not talk about it, unlike most major central banks.
The ECB is a horse of a different color. The situation is much more complicated. The euro area economy likely contracted in Q3. The German locomotive, while still resilient, has lost its pizzazz. And no wonder. It relies on exports, which is the aggregate demand from other countries, for almost 40% of its GDP. The slowdown in Asia and in Europe is a significant headwind. Moreover, with a relatively cheap currency, German producers have lost a powerful discipline.
The deteriorating growth profile, however, is taking place while price pressures appear to be firming. The September flash estimate indicated that CPI rose to 2.7% year-over-year for the second consecutive month increase and the highest level in seven months. The ECB simply cannot cut interest rates at Thursday's meeting.
Already some creditors, and not only, but especially Germany, are concerned that the soft money camp has taken over the ECB, which was supposed to inherit the Bundesbank's hard money DNA. To ease now would be to signal a frontal attack on the Bundesbank in particular. The risks are great and the economic reward of a 25 bp cut in the 75 bp refi rate is questionable at best.
The fact that the ECB is most unlikely to change policy does not mean that Draghi's press conference won't be interesting. Here we can expect some more clarification about the Outright Market Transactions and greater insight into how worried the ECB is over the renewed economic contraction.
There may be some discussion of its surrender of seniority in OMT operations and the legal status, of it. After all, when it had bought the Greek bonds, it bought them on a passu pari basis, and then pulled the proverbial rabbit out of the hat at the last minute.
Some observers suspect that another LTRO may be discussed or possibly a cut in the deposit rate below zero. Neither seems very likely, but if they are discussed, it does not mean that Draghi will reveal anything substantive. Recall that the ECB is one of the few major central banks that do not publish their minutes.