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ECONOMICS DEPARTMENT

Special macro comment

The ECB took four decisions today. Our assessment: positiveECB: refi rate

%

0

1

2

3

4

5

2004 2005 2006 2007 2008 2009

Source: Bloomberg

1. The refi rate was cut from 1.25% to 1.0%. The marginal

lending rate was cut from 2.25% to 1.75%, while the

deposit rate was left unchanged at 0.25%.

2. Within the framework of the ECBs enhanced credit support

operations, the ECB will make available to its

counterparties, refinancing operations with a maturity of 12

months. So far, the longest maturity on offer was sixmonths

3. The European Investment Bank (EIB) will be recognised as

a regular counterparty of the ECB as of 8 July, giving the

EIB access to the refinancing facilities of the ECB.

4. The ECB will engage in the purchase of covered bonds

issued in euro by eurozone residents.

Further details:

Sub 1.: During todays press conference, ECB President Jean-

Claude Trichet said several times that the governing council

has not decided that rates cannot go lower. Obviously, he said

that current rates are appropriate for achieving the ECBs goal

of price stability in the medium term.

Sub 2.:

The 12-month refi operations will be at a fixed rate and there

will be full allotment. The first operation will be open for tender

on 23 June. This first 12-month operation will be at the main

refi-rate (currently 1.0%) but future operations may be at a rate

including a premium.

Sub 4.:

This was only a decision in principle. Details of the

technicalities of these purchases will be decided on at the ECB

governing council meeting early June. Trichet said that the

amount involved may be in the order of EUR 60 bn. When

asked why buy covered bonds in particular, Trichet said that

the ECB feels that this asset class has been disproportionally

hit by turmoil and that the ECB wants to ensure that the

functioning of this market improves. Note that the key issuers

in this market are banks. Trichet refused to call this quantitative

easing and called in credit easing. This suggests that the sole

aim is to make this market work better, not to provide

additional liquidity.

ECBs economic outlook

Mr Trichets assessment of the economic outlook was

balanced and solid, no surprises. He acknowledged upside

and downside risks to growth and inflation. He suggested that

the worst in terms of economic contraction is probably behindus. This is in line with our and the consensus view. On the

downside, he highlighted risks of renewed turmoil in financial

markets and protectionism. But he also stressed that the

unprecedented nature, scope and timing of the policy response

is having positive effects. Trichet also said that headline

inflation is likely to fall into negative territory on a year-on-year

basis during the summer. But, he stressed, that is temporary,

due to base effects, and is not relevant for the conduct of

monetary policy. He did, however, acknowledge that inflation

pressure is easing further across the board. Several times,

Trichet stressed that inflation expectations remain well

anchored, in line with the ECBs definition of price stability.

On monetary developments, Trichet noted that the

deceleration seen in recent months in M3 and credit growth is

consistent with the positive assessment of the inflation outlook

and confirms that a process of deleveraging is taking place.

That is interesting because deleveraging is inevitable and

perhaps there is little point fighting against it.

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Trichet also expressed the view that governments must be

cautious as budget deficits are rising rapidly. In addition, he

called on policymakers to continue strengthening the structure

of their economies by continuing labour market reform aimedat making labour markets more flexible and product market

reform, aimed at fostering competition.

Assessment

We are encouraged by the ECBs decisions today. The

provision of unlimited 12-month liquidity support, at least at first

at the refi rate, should be a very significant boost to liquidity

and confidence. In addition, by lowering rates and stating this

is not necessarily the end to the easing cycle, the ECB has

implicitly committed itself to a very easy stance on monetary

policy for some time. This will be helpful in lowering borrowing

costs across the eurozone and also be supportive of

confidence. Third, the announcement concerning the purchase

of covered bonds shows that the ECB is willing to go further

than many people had thought likely. Last, recognising the EIB

as a regular counterparty is also positive as it gives the EIB

more flexibility.

Overall then, todays ECB decisions went a little further than

expected and must be seen as supportive of confidence and of

the economic prospects.