Central bank action expected today – euro rate cut or more asset purchases?

Publication date: 5 July 2012
Author: Mark Deans, Moneycorp

It took about 14 minutes yesterday afternoon for a member of parliament’s Treasury Committee to question Mr Diamond about the behaviour of his employees who attempted to swerve the Libor reference interest rate. He said it was reprehensible and that he really loved Barclays. Had the committee left it at that, everyone could have been home in time for tea. But no, the other 12 members asked exactly the same question. Three hours later the world was none the wiser, other than that MPs make useless interrogators and that it is A Bad Thing for a bank to influence interest rates – even if it does so for what it perceives as the greater good.

The stricture does not apply to all banks of course. In particular, if the Bank is capitalised (with a B, rather than with German taxpayers’ money from the ESM) it is permitted – even encouraged – to do just that. In Frankfurt today the Bank is widely expected to lower the euro’s Refinancing Rate from 1% to either 0.75% or, less likely, 0.5%.

In his brief tenure of the European Central Bank presidency, Mario Draghi has shown a willingness to reward resolve among EU leaders with action by the Bank. His last such move was the Long Term Refinancing Operations six months ago, which flooded the Euroland banking system with cheap three-year loans. Now, less than a fortnight after the Brussels Breakthrough, investors are assuming a rate cut.

A similar air of expectation permeates Threadneedle Street. Investors know from the minutes of the last Monetary Policy Committee meeting that there was only a narrow vote against a third round of asset purchases. With all they have heard in the last month from the chancellor and the governor, and in the light of weakening economic indicators from Britain and elsewhere, investors are confident that the Bank will announce something at midday. Another £50bn of asset purchases is seen as most likely but a low-balling of the Bank Rate is not impossible to imagine.

Like yesterday’s Treasury Committee hearing and the proposed judicial banking inquiry, the purpose of a euro rate cut or another round of asset purchases is not to achieve anything specific but to be seen to be doing something. With confidence at such a low ebb, anything that might improve it is worth a shot.

Certainly, confidence in the euro and the pound was in short supply on Wednesday. Both fell by nearly a cent against the US dollar and both lost half a yen. They also weakened against almost everything else. How they will perform on that broad front today, either with or without central bank action, is difficult to predict. Most likely is that yesterday’s weakness was in anticipation of moves by the ECB and BoE, and that the “sell the rumour, buy the fact” theory will allow the pound and the euro to recover today. For that to work, however, the Bank in Frankfurt and the Bank in London will have to do what is expected of them. That does not always happen.