Will Thursday’s ECB Meeting Surprise?

With the worries of a plunge over the fiscal cliff now receding, markets can get back to the business of worrying about the years-long problems that have been plaguing the Eurozone economies instead. This week, the focus will be on the European Central Bank which meets tomorrow to decide whether or not the current monetary policy is sufficient. While a recent poll of analysts and economists is predicting that the ECB won’t make any changes to policy this month, some analysts are holding out hope that Mario Draghi, who has been known to pull a surprise or two out of his hat, could move for a reduction in interest rates at Thursday’s meeting. An increasing number of analysts, however, expect that a rate cut won’t come before April at the earliest.

The Eurozone’s economy has steadily declined over the past several months, and the fourth quarter data suggested a deepening recession which is likely to encourage the European Central Bank to move more aggressively to promote economic growth, as they have long pledged. The ECB had already lowered its growth forecasts for this year, and could use an interest rate cut to attempt to stimulate growth; the ECB last set its current and historically low 0.75% rate in July 2012.

Analysts point out that a 25 basis points interest rate cut would effectively put deposit rates at the ECB into negative territory – meaning that depositors would essentially pay for the privilege of parking their money there. The hope is that such a move would encourage banks to lend more in order to get more bang for their buck as the saying goes, but critics argue that the rate cut is a disincentive for ordinary savers.

While such an action has been briefly discussed at previous policy meetings, analysts believe that the repercussions and ramifications are still being considered as there is certain to be some opposition emanating from the Eurozone’s core economies, i.e. Germany and France. However, some economists have argued that despite the abundance of cheap money, banks have neglected to pass that on; figures show that private sector lending had dropped by 0.8% in November much higher than the 0.5% expected, while the broader money supply, aka M3, fell to 3.8% from 3.9% in October.

The EUR/USD pair was recently higher at 1.3087, supported by a general improvement in investors’ risk appetite after the U.S. fiscal cliff issue receded. No significant data releases are expected this week except for Eurozone 4th quarter GDP which will be released today and is expected to be unchanged on a quarter-over-quarter basis from the -0.1% of the 3rd quarter. Tomorrow’s ECB rate cut announcement will be made at 12:45 p.m. (GMT) and in the absence of an interest rate cut, Draghi’s hint of one in the scheduled press conference which follows (1:30 p.m. GMT) could send the Euro lower in a knee jerk response.