ECB Gives an Inch, BOE Doesn't; and Bernanke?

The BOE and ECB left rates on hold as the vast majority expected.  The ECB's new staff forecasts shave the lower end of its growth forecasts for this year and next and Trichet sounds significantly more neutral than hawkish.  However, by noting that rates remain accommodative, at his second to last ECB meeting, Trichet did not move very far.  

There was no signal of a rate cut at next month's meeting, which means that barring some major deterioration in the credit or economic environment, the ECB is on hold.  This means that when Draghi takes over at the helm, he will not be in a position to establish his anti-inflation credentials by raising rates early in his tenure as so many had expected.  Instead, it is more likely that his first move, the first decision by a ECB president from a southern/debtor country will be to cut rates, even if not until next year.

The staff forecasts now see growth this year at 1.4%-1.8%, down from the 1.5%-2.3% previous forecast and next year's growth forecasts stands at 0.4%-2.2% form from 0.6%-2.8%.   Inflation forecasts were not adjusted much.  This year's inflation forecast of 2.5%-2.7% was not changed but next year's was shaved to 1.2%-2.2% from 1.1%-2.3%. 

There has been some speculation that the ECB could cut deposit rates.  This is the rate the ECB pays banks for excess reserves. It is currently set at 75 bp.  The other side of the corridor is the punitive lending rate, which is set at 2.25%. The key repo rate sits in the middle of the corridor.   

Of all the major central banks, the ECB has worked the hardest in trying to distinguish monetary policy from liquidity provisions. A cut in the deposit rate would in effect provide some disincentive for banks to hold excess reserves at the ECB and encourage them, however marginally to lend them out.  The issue here is that many banks have been cut off of wholesale financing that used to be available through the US money market funds. It should not be viewed as a rate cut.  It is about liquidity not monetary policy per se.  If the Federal Reserve cut the interest rate it pays on excess reserves, would investors think that the Fed has eased monetary policy?  

Separately, the US reported a considerably smaller than expected trade deficit in July.  This coupled with the jump in July personal consumption expenditures suggests that the US economy is off to a relatively strong start in Q3.  The real goods balance narrowed by $5 bln.  Imports (including the volume and price of oil) slipped 0.2%, while exports rose 3.6% to a new record.    

Of course, this is not to suggest that US economy is growing gangbusters, but simply that the latest prints do not jive with talk of a renewed contraction in Q3.  It looks like Q1 was horrible and Q2 only slightly better and Q3 a bit better still.  Output gap remains large and not closing very quickly.   

That said I would be surprised if Bernanke broke new ground later today.  Outlining options is the best we can reasonably hope for at this juncture.  President Obama's speech is a different story.  It probably should be thought of as his first speech for the 2012 presidential election.  

Separately, news that some Chinese officials have indicated that the yuan will be fully convertible by 2015 is likely to fuel speculation of further yuan appreciation.  Color me agnostic to skeptical on whether this is a true reflection of Chinese policy, which was not included it its current 5-year plan.  New generation/regime takes over next year.  There are too many wild cards--imponderables--to have much confidence in the veracity of today's claim.  However, it does succeed in stealing some thunder from some of Chinese critics and keeping them off balance.  It is a savvy move regardless of the ultimate outcome.  

The euro is proving pretty sticky on dips below $1.40.   Market participants may be better served selling into rallies than than playing the downside break outs.  I still think it is coming, but not quite yet.  The $1.4100 area should be tough now on the upside.   Sterling appears to have put in a base ahead of $1.59.   Potential now extends toward $1.6130 and possibly $1.62.   

It is tough to get excited about the yen.  Poor machinery orders (down twice the consensus expectation in July.  The is -8.2% vs consensus of -4.1% and offset June's 7.7% increase in full.  Only the investment income account is keeping Japan's current account in surplus.  The dollar-yen is in a 30 point range today.