ECB Holds Interest Rates, Sees Lower Growth & Inflation Ahead

On December 6, 2012, the European Central Bank (ECB) announced holding the benchmark interest rate where they were (presently at a record low of 0.75%). This was supported further by the stance taken by Bank of England, which maintained the base rate at 0.5%.

Bank of England also left its bond buying target unchanged at USD 604 billion. Media reports hinted that they could buy more bonds going ahead, if needed. This is a positive takeaway, as bond buying would infuse money into the system, helping the economy to grow.

Further, the ECB revised its GDP growth forecast for the Euro zone downwards by 20 bps to 0.3%. Just three months ago, the bank had estimated that the Euro zone would grow at 0.5%. The bank also expects the rate of inflation to fall around 1.4% by 2014, well below its initial estimate of 2%.

According to the ECB President, Mario Draghi, “Weak activity is expected to extend into next year, reflecting the adverse impact on domestic expenditure of weak consumer and investor sentiment and subdued foreign demand”.

Given the severe debt crisis it is facing, we believe that growth in the area would be difficult. Further, the GDP growth estimates for most of the countries and for the world have been revised downwards in the past. Hence, we opine that the downward GDP growth revision is already discounted by the markets. Also, the downward revision of the inflation target is a positive for the Euro zone. This is clear from the fact that the Asian markets, including India, remained positive in their opening trades.

All eyes would now be on the RBI and its policy, which is scheduled for December 18, 2012. Earlier in the week, the Reserve Bank of Australia (RBA) slashed the rates by 258 bps to 3%. Will the RBI go with the RBA, or will it maintain status quo on the rates in its meeting once again? Watch this space to read more as the developments unfold.