ECB Rate Cut: Too Little, Too Late?

Having tipped off the market at the previous monetary policy meeting that a rate cut was pending, the European Central Bank (ECB) followed through and lowered its benchmark refinancing rate on May 2 by 25bps to 0.50%. The marginal lending rate was slashed by 50bps, effectively squeezing the corridor that constrains the refinancing rate and EONIA (European Overnight Index Average).

Although the market had been positioning for a refi rate cut, with European equities rallying over the preceding days, the Governing Council’s decision has come a year (or more) too late. Peripheral eurozone economies continue to flounder, while even German growth has looked vulnerable this year after a long run of relative strength.

We see a further 25bps rate cut in the coming months, which will put the ECB’s rates more in line with other major central banks. Over the long term, the euro still appears overvalued and is set to weaken versus the US dollar. Yen weakness due to explosive quantitative easing in Japan will only pile the pressure on European exporters.

Our forecast of an average exchange rate of US$1.34/EUR in 2013 is still looking pretty good, but we are looking for depreciation towards US$1.20/EUR in the coming years with downside risks, as the US economy picks up.

This Week’s Trivia Question

In last week’s question, we asked, which historical figure’s lock of hair was sold for EUR13,720 at an auction house in Vienna that week? The answer is former Austro-Hungarian emperor Franz Joseph. For this week’s question, something totally different, inspired by reports earlier this week that an American soldier believed to be missing in action in the Vietnam War was found living in that country – although the reports were quickly debunked, and he was said to be an impostor. Our question is, which long running American TV series has a major character who also turned out to be impersonating a US soldier lost in Vietnam? (Hint: the character was a school teacher.) The answer will be revealed next Friday.