ECB To Stand On The Sideline While BOE To Extend Asset Purchases

Although Greece's PSI and its access to the new tranche of bailout fund dragged on, market sentiment appeared to have improved since the last ECB meeting. Moreover, reaction to the 3-year LTRO was positive while economic data over the past few weeks showed improvement. These should allow the ECB to keep the main refinancing rate unchanged at 1% and leave the unconventional monetary measures unchanged.

The EU summit held in early February made little progress. The leaders, except the UK and Czech Republic, agreed to sign a Germany-inspired fiscal pact. However, it's understood that it would take a long time for the sovereign debt crisis to be cured. Economic data released since the January showed improvements, though. The Eurozone PMI rose to 50.4 in January, returning to expansionary territory for the first time in August. Economic sentiment also strengthened as indicated in ZEW expectations indices. Headline inflation eased to +2.7% y/y in December from +3.0% a month ago.

In January, the ECB stated that economic outlook in the region is with 'substantial downside risks' due to 'a further intensification in the tensions in euro area debt markets and their potential spillover to the euro area real economy'. President Draghi noted during the press conference that while 'some survey data' were 'positive', the 'hard data do not yet show this'. We will likely receive similar comments at the February meeting.

In the UK, the BOE is expected to expand its asset purchases by 50B pound in February. The country's economy has remained subdued and the stubbornly high inflation has started to moderate. Moreover, the previous asset purchase program is about to expire. The February meeting is probably the best timing to extend the amount further.

GDP contracted -0.2% q/q in 4Q11, after a +0.6% growth a quarter ago. On annual basis, the economy expanded +0.7%, up from +0.5% in 3Q11. Industrial activities weakened and it's increasingly likely that the economy will fall to a mild recession last in the year. Inflation eased to +4.2% y/y in December from +4.8% in the previous month. Core CPI, which excludes energy, food, alcohol and tobacco, also moderated to +3.0% from +3.2% in November. Easing inflation should give the central bank more comfort to extend and expand asset purchases.