The interest rate announcement from the European Central Bank headlines the economic calendar for the forthcoming session, with expectations calling for a 50 basis point cut to bring rates to 2.0%. Overnight index swaps suggest the markets have priced in the outcome, so the reduction itself is unlikely to stir much volatility. Rather, most attention will be directed at President Jean-Claude Trichet’s comments accompanying the announcement for clues as to where money policy will go next. Traders are betting on another 75-100 basis points in easing over the next 12 months. The ECB has been particularly reluctant to cut rates as aggressively as the US Federal Reserve or the Bank of England. Inflation has fallen sharply - indeed, the Euro Zone Consumer Price Index is expected to see inflation confirmed at 1.6% in the year to December, below the ECB’s 2% reference level - giving the bank ample room for a looser posture. The tone of Trichet’s comments poses a dual threat for the Euro: if he is very dovish, he will boost expectations of future rate cuts which will weigh on the single currency; alternatively, if he is not dovish enough, this will be perceived as a threat to long-run economic growth and may also add selling pressure to the Euro.
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