Unconventional outlook for ECB and BOE

Tonight is an exciting night for us monetary policy types. The BOE and ECB have announcement windows, and there is much speculation about what both central banks will do.

For the record, I think that the BOE will do more LSAPs (probably 50bn GBP, almost certainly Gilts only), and that the ECB will disappoint by announcing only a 1yr LTRO.

The market is mostly convinced that the BOE will do more QE, but thinks the Old Lady will wait until November. My experience is that (excepting the ECB) central banks see it before the street, and so get there first. Also, it is (theoretically) good to surprise by being easier than expected.

We can all see the case for easier money in Europe – so why do I think the ECB will not act? Because they want to seperate monetary and (psuedo) fiscal policy, and because Trichet would see a total reversal as an admission of prior error.

The ECB hates the SMP. It is psuedo fiscal policy, and they would sooner not be involved. They have shown their disdain for this dirty work by tightening interest rate policy at the same time as they were buying distressed Peripheral Sovereign Debt.

This was a somewhat a disengenous seperation, however it made clear that interest rate policy would remain focused on their primary target (price stability); and that the SMP – a maturity transformation and credit-risk reallocation policy which is properly the domain of elected fiscal authorities – was seperate from and subordinate to their price stability objective.

Of course we all could see that higher rates were hurting the fiscal situation of the weakest economies, but the ECB makes interest rate policy in response to the German unemployment rate (which is still declining) so none of that mattered. The consequent problems were for elected officials to work out.

Those looking for Trichet to end his tenure with a complete reversal of the 2011 tightenings misunderstand Trickey. Trichet continues to defend the July 2008 rate hike, and I think he really believes it was the right thing to do – even knowing what followed.

I think Trichet would see his legacy as best defined by the July 2008 hike, and the muscular 2011 tightenings. These established his (and the ECB’s) inflation fighting credibility. I doubt that he would want to give it away at his final meeting.

We will find out soon enough – goodluck (sell some cable for me!)