Busch: BOE Stays on Hold, ECB Cuts
Today, the Bank of England left rates and quantitative easing on hold as Governor King decides to wait before more additional easing measures are taken and says that the events in Europe are beyond his control.
In October, the BOE surprised the markets with an aggressive increase in QE by 75bln GBP to 275bln GBP. These purchases will be completed in February and the current market expectations are for more QE then. This is despite the downgrade to the 2012 GDP forecasts by not only the central bank, but also by the OBR (Office of Budget Responsibility). While King is correct that European circumstances are beyond his control, but not acting now to address the rapidly declining economy and not preparing the UK market for an exogenous event out of Europe appears to be whistling past the graveyard.
Speaking of the dead, the ECB cut interest rates today by 25bps to 1.0%, they lengthened the Long Term Refinancing Operations unlimited lending facility to 3 years from 12 months,they eased collateral rules at the central bank and they cut the reserve ratio from 2% to 1%. These were all done in the hope of easing the liquidity crisis for European banks especially during the turn of the year crunch. Sadly, this doesn't address the solvency issue for the banks and sovereigns. During the press conference, ECB President Draghi stated that he didn't signal more bond purchases (SMP) and took away the major item that would've helped on the solvency issue.
Equity markets and Risk-On tanked after this comment on bond purchases. This is precisely what I was concerned about on Monday and Draghi didn't disappoint. He needed to walk back the recent rumors/leaks/comments by the ECB on what they would do to assist European leaders if they agreed to a fiscal compact. This is the cudgel needed to prompt compliance and cohesion amongst the 17 Euro zone members to act. It is the razor's edge that must be walked by the ECB or they end up rewarding the fiscal miscreants within the monetary union.
Thus, the ECB sets the stage for the European Union leaders' summitand sends a strong signal that there will be no reward without meaningful action. While the Germans may attempt to be walking back expectations on the outcome, Draghi is telling them to run forward or risk falling backwards.
I believe the EU leaderswill debate the proposals from "Merkozy", provide reassuring comments of the necessity of the changes and agree to move forward on them. However, they will not move with the speed that the markets require. Germany and France (and whoever is left with AAA ratings) will be forced to move ahead, skirt the issue of referendums and ultimately tell other Euro zone members to join or risk the abyss. This translates into more volatility for markets heading into Q1, but with a downside protected by global central banks acting in unison (rate cuts, US dollar lending, currency intervention, etc.).
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.