ECB meeting preview: Rate cuts in sight?

The task of predicting what the European Central Bank might do tomorrow at its monthly meeting got a great deal tougher as a result of Greek Prime Minister Papandreou's announcement of a vote of confidence, to be followed by a referendum on the latest EU bail-out package, however, nowhere near as tough as the challenge European Central Bank President Mario Draghi and his Governing Council face.

October meeting laid the groundwork
In many ways the statements made after the October meeting laid the groundwork for cuts, either tomorrow, or in December. Growth risks were said to be, 'to the downside' and inflation risks, 'broadly balanced'. If anything, subsequent data prints indicate further deterioration, especially business surveys, including the disappointing Eurozone Composite
Purchasing Managers' Index, which read 47.2, well below the key 50 level, which suggests impending economic contraction and also below expectations, which were at 48.8.

Inflation an irritant
The latest estimate for headline Eurozone inflation stands at an irritating, (for the ECB), level of 3.0 percent, versus their target of close to, but just below, 2 percent, but even this most hawkish of institutions told us in October that it expected the rate to, 'stay above 2 percent over the months ahead but decline thereafter'. Well, this week's developments must surely give them huge concern for business and consumer confidence, including workers' ability to insist on inflationary wage rises.

Liquidity provision
Having announced two new LTRO's, (Long Term Refinancing Operations), in October; one of 12 months and the other 13 months duration, (with the rate applied being the average of the rates of overnight ECB refinancings over the life of the LTRO), one would not expect the announcement of any further such measures tomorrow, however should funding pressures intensify over the coming weeks, it is not impossible that subsequent meetings see the introduction of either 24 month programmes and/or use of a rate on such deals which is fixed at the current main Refinance Rate at the time, if that is needed to force down term interbank market rates, as it was in 2009.

Main Refinancing Rate
The headline rate which the ECB charges for overnight liquidity-there must now be a greater than 50 percent chance that this is cut by 25bp tomorrow, with a cumulative cut of 50bp by Christmas a virtual certainty, in my view. Identical cuts in the deposit facility rate, currently at 0.75 percent, must also surely come, if only to dissuade banks from continuing to park vast sums with the ECB, rather than lending to each other or non-financial companies.

Peripheral Bond Buying
I have left the most important measure until last. In a sense, the level of ECB interest rates is a mere side-show compared to the ECB's thus far rather limited peripheral sovereign bond buying programme. Were the ECB to announce it would buy unlimited amounts of such bonds, it could 'solve' the Eurozone debt crisis at a stroke for, although the underlying insolvency problems of some states would still need attention, the immediate liquidity concerns that kill banks, brokers or countries would disappear in a flash.

In the face of virulent German, (and other Northern countries'), opposition, this won't happen this time or next-but who would bet against that being the ultimate, desperate denouement for this story?