ECB and BoE Stand Pat in June

HIGHLIGHTS

• ECB and BoE left policy rates unchanged at 1.00% and 0.25% respectively.
• ECB spreads asset purchases over the next year

Both the European Central Bank and Bank of England decided to leave interest rates and monetary policy generally unchanged at their meetings this morning. The ECB also provided additional information on how they plan to carry out their asset purchase program as well as released new staff forecasts. There is no doubt that we are seeing economic activity start to bottom out and work its way back into positive territory. But both central banks are likely to remain very cautious in their forecasts and language through the rest of this year until it is certain the recovery will be sustained into 2010.

The entirety of the statement from the BoE was:

“The Bank of England's Monetary Policy Committee today voted to maintain the official Bank Rate paid on commercial bank reserves at 0.5%. The Committee also voted to continue with its programme of asset purchases totalling £125 billion financed by the issuance of central bank reserves.”

The U.K. economy has been showing significant signs of improvement. Mortgage approvals have risen for three months in a row, PMI indices have continued to rise significantly, and home prices have also surprised on the upside, with the Halifax report released today showing a 2.6% increase in May. The rapid cuts in interest rates and aggressive plan of quantitative easing appears to be helping the U.K. economy recover strongly during this “green shoots” period.

While the ECB made no change to policy, they did clarify their plan to purchase EUR60bn in covered bonds. While the plan itself is small compared to asset purchase plans in the U.S. and U.K. - and is not actually quantitative easing as these purchase are being financed with existing reserves of the ECB and not newly printed cash - the impact of this plan was further watered down in the details. The purchases will begin in July and be spread over the next 12 months, so this will largely be token support to help the financial sector but is unlikely to make a material impact.

The ECB staff also revised their GDP and inflation forecasts. GDP is forecast to fall in the range of -4.1% to - 5.1% in 2009 and -1.0% to +0.4% in 2010. If evenly distributed, this implies a midpoint forecast for 2010 of -0.3% and President Trichet explicitly said they do not see positive quarterly growth until the second half of 2010. While we do think there is an ongoing tail risk that the Eurozone economy will contract in 2010, our base case is for positive growth above the 0.4% upper range the ECB staff forecasts currently project. As a result, we think the ECB is setting up a high hurdle for any further easing, and in fact makes it easier for them to begin raising rates sooner. This is confirmed in their new inflation forecasts. In spite of the substantial downward revision to economic growth in 2009 and concerns the labour market will deteriorate more than previously expected, the staff left their inflation forecasts relatively unchanged, with a range of 0.1-0.5% y/y HICP consumer price inflation in 2009 and 0.6-1.4% in 2010.

We do not see an imminent return to hiking by either central bank given our economic and commodity forecasts, and further easing remains possible. We expect the ECB will begin hiking in Q2 of 2010; however, if the recovery continues near the current pace and oil prices remain strong, we could see the ECB raise rates as early as the first quarter of 2010, as a result of the low bar they have set for the Eurozone receovery.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.