• ECB leaves rates unchanged but acknowledges weak economic prospects
  • Statements hit at concerns about worsening jobs outlook
  • Dramatic change needed to force ECB’s hand anytime soon
  • Possibility of more non-standard support in Autumn
  • Rates unlikely to rise before second half of 2010

Today’s decision by the European Central Bank to leave its key policy interest rates unchanged was universally expected. That is not to say that the policy outlook is completely clear cut. Today’s surprise rate cut by the Swedish Riksbank and growing expectations that the Bank of England may step up the scale of its quantitative easing highlight a widely held view that further policy action maybe needed to put economies and financial systems on a healthier path. Clearly, the ECB is mindful of this possibility.

The notable feature of the ECB’s monthly press statement today was the extent to which it remains cautious about the outlook for activity in spite of a continuing improvement in survey-based indicators of late. Mr Trichet was careful to signal that the ECB is likely to remain on hold for some significant time and also said that upside and downside risks both to activity and inflation remain balanced. However, he added once again that the ECB has not entirely ruled out the possibility of further rate cuts. More significantly, the press statement contained some subtle changes from last month that hint at continuing concerns about the Eurozone economy. First of all, the ECB reiterated that the second half of 2009 should see some improvement but today’s indication that activity ‘should decline less strongly’ seems a less confident assertion than June’s observation that activity would decline at ‘much less negative rates’. The ECB also added ‘further increases in oil and other commodity prices’ as a downside risk and highlighted the risk of ‘a stronger or more protracted negative feedback loop between the real economy and the turmoil in financial markets’. This threat may be linked to particular fears about the jobs market. Certainly today’s acknowledgement of the risk posed by ‘increasingly unfavourable labour markets’ strikes a more worried tone than last month’s reference to ‘more unfavourable developments in labour markets’.

It may be that this tweaking owes something to today’s news that unemployment rates in the Eurozone and in the US both jumped to 9.5%. The European figure is the highest since the Spring of 1999 whereas the US number is the worst since 1983. Several recent comments by ECB officials suggest worries that a degree of labour ‘hoarding’ (via short-time working schemes) may be happening in several European countries. In the event of a weaker end to 2009, a further marked rise in unemployment could follow in 2010, with adverse consequences for spending in the economy and the health of the financial system.