• Début. He came, he saw, he cut – that sums up the interest rate decision after Draghi took office, when to everyone’s surprise the ECB Governing Council cut the refi rate yesterday by 25 basis points to 1.25% and, therefore, removed half of the tightening from the spring. The roadmap for the unconventional measures remains unchanged. Markets had priced in rate cuts, but not at such an early date.

• Reactions.The euro, already rattled by the squabbling over Greece, initially eased further; equities and commodities, in contrast, posted strong gains. Spanish and Italian sovereign yields also profited, with the latter having risen to a new high before the meeting. German government bonds came under pressure (page 19).

• Reasoning. The Governing Council’s decision, according to Draghi, was in reaction to the deterioration of the economic development that is driving the eurozone towards a mild recession. He also cited the retarding effects of the ongoing tensions on financial markets. Moderating inflationary pressure created scope for this rate cut. The seemingly more proactive ECB stance leaves the door open for an additional 25bp cut as early as next month (pages 2-3).

• Referendum. At the beginning of the week, Greek Prime Minister Papandreou snubbed markets and EU policymakers alike with his proposal for a referendum on the debt deal. EU & IMF funds were put on ice. The referendum is now off the table, and the risk of a disorderly default or an EMU exit has faded. But uncertainty remains high.

• Further topics:

  – Fed:Bleaker macro forecasts point to further easing (page 4).

  – Germany I: Reform success as a blueprint for Europe (page 6).

  – Germany II: Debt ratio falls (page 9).

  – Commodities: Short-term downside risks (page 12).

  – Date outlook: Industrial production across EMU declines (page 16). – Market outlook: Euro to tend sideways (page 20).

A more pro-active ECB?

• In a surprise move, yesterday the ECB cut the refi rate by 25bp to 1.25%. The deposit rate and the marginal lending rate were also lowered by 25bp.

• The ECB’s tone has become significantly more relaxed on inflation, and this seems to suggest that the refi rate may be cut further, possibly as soon as in December.

• Judging from the press conference, Draghi’s ECB may be more pro-active and quicker to respond to changes to the CPI/GDP outlook than Trichet’s.

• This is something which caught us a bit off guard, but may well be a positive development.

Draghi’s mandate starts with a surprise

In a surprise move, yesterday the ECB cut the refi rate by 25bp to 1.25%. The deposit rate and the marginal lending rate were also lowered by 25bp, to 0.5% and 2%, respectively. We had expected no rate change, based on the assumption that still solid hard data, 3% inflation and no signs of deterioration in lending data up to September would have convinced the central bank to hold its fire. In contrast, the ECB’s tone has become significantly more relaxed on inflation, and this seems to suggest that the refi rate may be cut further, possibly as soon as in December. Judging from the press conference, Draghi’s ECB may be more pro-active and quicker to respond to changes to the CPI/GDP outlook than Trichet’s. This is something which caught us a bit off guard, but may well be a positive development.

Press conference: the highlights

These are the main points of the press conference:

– The main rationale of the rate cut is the marked deterioration in the growth outlook as visible in several economic indicators, mostly survey data, which flag a materialization of some of the downside risks previously identified. Draghi pre-announced a significant downward revision to the ECB’s 2012 GDP forecast to be published next month, which is going to envisage a “mild recession” at the turn of the year (i.e. GDP growth is probably seen negative both in 4Q11 and 1Q12). Here we have the first hint of a more forward-looking approach: up to last month, the ECB’s economic analysis provided explicit indications only for the expected growth dynamics in 2H11 (seen as “very moderate”), while Thursday's assessment looks beyond that and states, “Ongoing tensions in financial markets are likely to dampen the pace of economic growth in the euro area in 2H11 and beyond”.

The ECB expects that the worsened growth prospects will lead to a weakening of inflationary pressures, with consumer prices seen falling below 2% in the course of next year.

– Yesterday’s rate action aims at keeping mid-term CPI risks broadly balanced. This implies that, in the absence of a rate cut, the balance of risks to price stability as perceived by the ECB would have shifted to the downside. Interestingly, Draghi decided to push ahead with the cut without preparing the market for the move. To us, this means that we should probably expect the “new” ECB to be more reactive to changes in economic and financial conditions, implying a stronger emphasis on a risk-management approach to monetary policy. This is the second hint of a more pro-active stance.

– In addition, the monetary analysis unveils a more forward-looking approach. While acknowledging that the latest lending data still look ok, Draghi explicitly mentioned the possibility that adverse financial market conditions may impact credit supply with a lag, therefore calling for close scrutiny of credit developments down the road.

– Importantly, the rate decision was unanimous. This is good news, because it alleviates fears that the Governing Council may have split on conventional monetary policy (we already know that there are some view divergences when it comes to unconventional policies).

– The ECB’s line on the SMP is unchanged, as Draghi stressed that govie purchases are temporary, limited, and intended only to restore the normal functioning of the monetary policy transmission mechanism.

More room for easing

What to expect next? The introductory statement does not mention that rates are appropriate, meaning that the ECB retains an easing bias. Moreover, the reference to short-term rates remaining low is no longer there. When asked about the future course of monetary policy, Draghi stated that the central bank never pre-commits. This leaves the door open to additional easing of conventional monetary policy in the very near term, possibly as soon as next month. The refi rate floor should be 1%.

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