No Surprises From The ECB Expected This Week

FRANKFURT -- The European Central Bank may have recently shocked markets with an unexpected rate cut, but analysts are not expecting a repeat showing after this week's governing council meeting.

"One hesitates to say lightning doesn't strike twice, but I would be shocked if the bank repeated the dose," Jeremy Stretch, currency strategist at RBC Dominion Securities in London, told FX Week. "It will be another month before we see a rate cut from the ECB."

The central bank performed an apparent U-turn two weeks ago when it cut interest rates by 25 basis points, in spite of repeated assertions in recent months that euro-zone rates were at the correct level. As the bank's other G7 colleagues slashed borrowing rates repeatedly, the ECB stood firm, insisting that the US slowdown was not impacting euro-zone economics, in spite of some worrisome growth indicators from Germany.

The central bank justified the recent cut by highlighting recent M3 money supply data, which analysts said was unusual, as the data set has received relatively little attention in recent months. Market participants also highlighted the damage done to the ECB's credibility.

"The confusion in the market after the recent cut shows how far apart the ECB and the Fed are," a senior dealer at a German bank in Frankfurt, told FX Week. "Where the Fed is decisive and clear in its communications with the markets, the ECB's decision-making process shows a lack of transparency, and this is not helping their credibility."

Some observers argued that last week's Federal Reserve interest rate cut (FX Week, May 14) will make it less likely that the ECB will cut this week. With the Fed still clearly concerned about the US economy, some investors are banking on a recession being avoided, thus improving the environment for euro-zone exports.

However, the manufacturing sector in the euro zone remains a concern and would benefit from lower interest rates, analysts said.

"I guess it's never say never after the last meeting, but we don't see any cuts this time around," Steven Saywell, currency strategist at Citibank in London, told FX Week. "We do see another cut in Q3 though."

The euro is unlikely to glean any upside from events in Frankfurt this week, observers said. In spite of a brief knee-jerk upside reaction to the recent shock cut, the single currency has been mired near the $0.88 level, and many analysts are forecasting the euro's bearish run to continue. The euro has been underpinned in recent months by a build-up of resistance at the $0.87 level, but if this level were to be pierced "that would open the way for the euro to fall towards $0.82", the Frankfurt-based trader said.

However, it may not be all bad news for the 12-nation currency.

"The ECB's activities are not the pre-eminent driving force in the FX markets at present," RBC's Stretch told FX Week. "There is already a lot of bad news priced into the euro zone, and the market is beginning to worry that [Federal Reserve chairman Alan] Greenspan may not be able to turn the US economy around as quickly as was expected."

The ECB's decision is announced at 12:45 GMT this Thursday (24 May).