Will the ECB reverse policy direction tomorrow and cut rates or signal that a change may come in the near future?
The economic pieces would seem to be in place. The EMU is in recession, inflation is low, unemployment is rising and the forward indicators, particularly the purchasing managers surveys point to an intensifying economic contraction.
But for ECB President Mario Draghi and the governing council there are two huge impediments. They are committed to the preservation of the euro. Italy and Spain are in dire economic straits, and the road to a bailout, if either ever needed one, is long and tortuous. The ECB badly needs to keep the confidence of the private credit markets intact and the markets care about budget austerity and repayment. A rate cut could be seen as a sign of weakening resolve at the ECB on inflation and austerity. The bank cannot afford anything that undermines its credibility. The drop in Italian and Spanish rates since last summer was due entirely to the threat of ECB intervention. That threat, if examined, is far weaker than it appears because the bank cannot act until a bailout is accepted by Madrid or Rome.
The second impediment is much simpler. A 25 or even 50 basis point cut in rates will do little or nothing to improve the European economy. Europe's problems are fiscal, political and structural not cyclical. The balance on an ECB rate reduction is still heavily against any change from 0.75%.
Chief market strategist