The European Central Bank (ECB) has left the main refinancing rate (key rate) of the Euro zone unchanged at 4.25% at its today’s meeting.

 

The following new GDP growth and inflation forecasts have been presented (mid of range):

Expected values for 2008: GDP growth 1.4 previously 1.8%; Inflation 3.5 previously 3.4%

Expected values for 2009: GDP growth 1.2 previously 1.5%; Inflation 2.6 % previously 2.4%

 

Market reaction: In a first move EUR bond prices rose.

 

Assessment: President Trichet emphasized once more the current wait and see stance of the central bank, a rat cut in the near future can be ruled out. After all, the bank not only raised its inflation forecast for this year, but also for the year 2009, whereby the average inflation is projected way above the envisaged upper limit of 2 % yoy. Moreover, the recent slump in leading economic indicators seems not to have impressed the bankers much. The ECB council still expects only a temporary trough in economic growth, which has been anticipated anyway. Though GDP growth forecast for 2009 was lowered, starting from the fourth quarter of 2008 the economy should step by step gather speed again.

 

Outlook: We do not share the view of the ECB about the economic outlook. First, we reckon with weak economic growth far into the year 2009. Second, we do not expect broad based second round effects pushing up inflation rates by that much as the price setting power of firms should decline significantly. We forecast inflation rates (recently at 3.8% yoy) to fall back to ca. 3% yoy by year-end and about 2% yoy by mid 2009. According to our assessment, inflation rates will decrease by almost two percentage points and economic growth by about one percentage point (decline from 1.4% in Q2 08 to 0.6% yoy in Q2 09) within the next nine months. As a consequence, after some months of unchanged key rates we still expect the ECB to cut rates, whereby we forecast rate cuts of in total 75 basis points by mid 2009 (from currently 4.25% to 3.5% in June 2009). Because of the unchanged attitude of the ECB for the time being, money market rates will remain at the current high levels for at least the next two months. Moreover, our short term recommendation for EUR bonds is left at Neutral. Only on a three to six month horizon we expect a further substantial decline in bond yields.