Euro Traders Speculating On 50bps ECB Cut And Beyond

The European Central Bank is scheduled to announce its rate decision tomorrow at 12:45 GMT. With global rates sinking quickly towards zero and conservative estimates for growth finding continuous, negative revisions; this ECB rate decision may very well redefine the euro's dominant fundamental bearing

The Economy And The Credit Market

The European Central Bank is scheduled to announce its rate decision tomorrow at 12:45 GMT. With global rates sinking quickly towards zero and conservative estimates for growth finding continuous, negative revisions; this ECB rate decision may very well redefine the euro's dominant fundamental bearing. Until recently, the Euro Zone was expected to see growth that would outpace its global counterparts and a pace of interest rate cuts that was far more reserved than that of its G10 counterparts. Optimistic growth projections have already begun to fall away, but interest rate expectations are slow to turn (especially after the Fed dropped its target rate to a range near zero). However, the conservative estimate from economists is calling for an additional 50 bps cut this Thursday that would bring the benchmark to 2.00 percent. At this level, there is little cushion before the ECB joins the Fed and Japan near zero. With a sizable cut and dovish commentary from President Jean-Claude Trichet, the euro's future is now at the whims of speculation that balances the pace of easing with timing for the eventual turn in economic activity. Should a zero rate policy seem probable, the euro will likely collapse.

A Closer Look At Growth And Financial Conditions

Looking at the traditional gauges for monetary policy, there seems little reason for monetary policy makers to back off their steady pace of rate cuts now. Over recent months, dour growth indicators have evolved into truly ominous forecasts. With the third quarter GDP number, the Euro Zone was tipped into a technical recession. More timely indicators have been even more discouraging. The German government reported growth through all of 2008 slowed to a 1.3 percent clip while consumer confidence for the entire region has plunged to its lowest level on record. In turn, market participants and policy makers have forecasted the worst of the recession to develop through 2009. And, with expansion grinding to a halt, inflation that is on target (and expected to slow further) merely opens the door to cuts.

If the economy were undergoing a natural recession, hawkish currency traders would have a better case for speculating a benchmark lending rate that held above 1.00 percent until growth trends turned around and global interest rates leveled off (and subsequently imparting the euro with a natural yield advantage that could leverage its appeal through a rebound in risk appetite). However, this is not the typically recession – which should be clear through its global spread. Feeding into the drop in activity is the ongoing financial crisis. While policy authorities have expanded bailout packages, guarantees, liquidity injections and stimulus plans; these actions have merely eased credit for banks. Until credit is available to consumers and businesses, the economy will suffer.

DailyFX

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