Market sees only 25 bp cut on Thursday

Author: Jamie Coleman | Category: News

The 50 bp cut from the ECB that many had hoped for to help battle the European banking crisis looks less likely today despite no improvement in the sovereign debt/banking crises. Last month’s spike in Euro zone inflation took 50 bp off the table but the market still sees a cut as Trichet’s term comes to a close. They will say the cut is due to falling inflation expectations over the “relevant policy horizon”.

In reality, the cut will be a unwinding of the ECB’s overreaction to an oil price shock, the second time they have made the same mistake (July 2008 and July 2011) .

The move will also be made this week to save the incoming ECB chief (an Italian, so automatically suspect as an inflation-fighter despite all evidence to the contrary) the scrutiny of reversing his predecessors monetary policy.

At present, the market has 47 bp of easing priced in over the next 12 months…

If the ECB does not cut at all, expect a very short-lived knee-jerk reaction to cover shorts on an interest rate differential basis. That should then be followed by a very steep slide in EUR/USD on the idea that the ECB is deeply and persistently behind the curve…

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