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ECB Holds Rates, Slashes Growth Forecasts: Rate Cuts to Come

ECB Holds Rates, Slashes Growth Forecasts: Rate Cuts to Come

The European Central Bank this morning kept rates on hold at 0.75 percent and did not launch any new policies as the European economy continues to suffer under the weight of its own debt. President Mario Draghi, since launching the Outright Monetary Transactions (OMT) scheme this summer, has yet to activate the program since neither Spain nor Italy have requested a formal EU/Troika program.

In it's latest growth and inflation forecast, the Bank's economists did paint a much more bleak portrait of the European economy than they had in the previous set of forecasts. The ECB cuts its 2012 growth forecast to -0.4 to -0.6 percent annualized growth and slashed its 2013 estimate to between a 0.9 percent contraction and a 0.3 percent growth. Previously, the ECB had forecast 2013 growth to be between a 0.4 percent contraction and 1.4 percent growth. Further, the Bank cut its inflation forecasts for 2013 to between 1.1 and 2.1 percent, with the midpoint of the range below the ECB's target of 2 percent inflation.

One notable point from Draghi's press conference was his discussion of the decision to leave rates unchanged at 0.75 percent. Although the consensus forecast was for no cut in the benchmark rate, some economists have suggested that a 25 basis point cut in the rate is needed. However, Draghi said that there was a "wide discussion" on rates at the meeting and that the decisions was "taken by consensus." This could hint that the ECB Governing Council is becoming more and more divided on rates and could cut rates in the near future if the economic outlook worsens.

Famed economist Nouriel Roubini, famously called Dr. Doom for his bearish calls in late 2007 and early 2008 before the collapse of the financial system, was on twitter this morning saying that with growth and inflation forecasts falling below the ECB targets, the Bank will have to ease in 2013. As the Bank has been against outright QE, easing will most likely come in the form of further rate cuts and the activation of the OMT, most likely by Spain and Italy in 2013.

Analysts at Credit Suisse agree with Roubini's assessment of 2013 policy. The strategists there believe that Central Banks, to make any real impact on employment in 2013, will need to drive down real 10-year bond yields to between -1.5 percent and -2 percent. With real yields hovering near -1.0 percent, this would require the banks to print significant amounts of money and make large-scale asset purchases to drive rates lower.

There are many headwinds facing the European economy in 2013, and this is reflected in the bearish forecasts for the eurozone economy. There is uncertainty as to whether the OMT will be activated by either Spain, Italy, or potentially another member of the currency zone. Also, a German downgrade, as rumored about in the first quarter of 2013, could spark a new round of the crisis which calls into question the finances of the healthy countries, let alone the failing peripheral states.

<p.investors can="" take="" a="" bearish="" bet="" on="" the="" continent="" by="" shorting="" euro.="" for="" those="" not="" trading="" currencies="" currencyshares="" euro="" trust="" class="ticker" href="/stock/fxe#NYSE">FXE) is an ETF that tracks the euro and shorting it can allow the investor to place a bearish bet on the currency. Also, for those who do trade in the FX market, shorting the EUR/AUD seems attractive here. With the breakout in the AUD/USD above 1.05 this morning and the breakdown below the uptrend dating back to last summer in the EUR/AUD, shorting the pair looks attractive at current levels.</p.investors>


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