Today the Bank of England cut rates, the ECB did not. The ECB’s words, however, carried a lot of weight. The BOE cut rates by 50bp to 1.0%, and left the door open for further cuts to offset substantial downside risks to its inflation target. The ECB left rates on hold as expected, but the press conference signaled a very important step forward towards a more pragmatic and decisive policy stance: another 50bp cut in March seems all but certain, but, most importantly and surprisingly, a Zero Interest Rate Policy has suddenly flashed on the ECB’s radar screen of policy options. Moreover, it seems that the Governing Council is carefully considering the scope for quantitative easing measures that might include direct purchases of sovereign and corporate bonds, although Trichet indicated that the bank would not discuss specific measures until it was ready to deploy them. This suggests that the ECB is increasingly worried by the seemingly unstoppable collapse in eurozone activity, and less hawkish in its assessment of inflation risks: the statement mentions both downside and upside risks, but the latter sound very theoretical in the current environment, the former much more concrete. Trichet today said the ECB is “not in the same universe as other central banks.” This is exactly what many of us have thought for some time, but today it seems to me the ECB has realized that in their universe the same laws apply. I also believe that as they embrace an even more decisive policy response, their thoughtful concern for maintaining confidence in the medium term sustainability of policies will carry more and more weight—this is an area where the ECB could take the intellectual leadership once they have shaken off the accusation of being behind the curve.
The Bank of England cut interest rates by another 50bp today, lowering the policy rate to 1.0% . This is two full percentage points below the December CPI reading of 3.1%. The Bank emphasized its confidence that rate cuts would have a significant impact on the economy notwithstanding the financial sector dislocations that hamper the monetary policy transmission mechanism. Importantly, the BOE noted that while the economy would eventually benefit from the easing in monetary and fiscal policy, lower commodity prices and a weaker currency, the risk of undershooting the 2.0% CPI target remained substantial. This in my view keeps the door open to further rate reductions, and we still expect the base rate to fall to 0.50% next month.
