1. Meeting: October 2nd 2008
Next meeting: November 6th 2008
Rate cuts: when, not if.
Miguel Jiménez
mjimenezg@grupobbva.com
• The ECB’s Governing Council has left its key official
rate unchanged at 4.25, as expected. However, the Pedro P. Álvarez Lois
option of cutting rates today was also discussed. pedro.a_lois@grupobbva.com
• Uncertainty is “extraordinarily high” for the ECB Agustín García Serrador
Council. Downside risks to growth have clearly agustin.garcia@grupobbva.com
increased, while upside risks to inflation has
“diminished somewhat, but not disappear”.
• Although there is high uncertainty about the timing, ECB official rates
our central scenario is now for a rate cut of 25 bp at 4.50
next month’s meeting, and further cuts during 2009 4.25
down to 3%. 4.00
3.75
3.50
The recent intensification of the financial market turmoil was at the heart
3.25
of today’s Council discussions. The deterioration of growth prospects in
3.00
the euro area confirmed by recent indicators and aggravated by tighter
2.75
financing conditions, together with diminished upside risks to price 2.50
Nov-08
Nov-09
May-08
May-09
Jan-08
Mar-08
Jul-08
Jan-09
Mar-09
Jul-09
stability, have led to the consideration of a rate cut by the Governing
Sep-08
Sep-09
Council. The policy decision to keep rates unchanged was unanimous,
but Mr. Trichet made clear at the very beginning of the press conference Current BBVA forecast Previous BBVA forecast
Source: ECB & SEE BBVA
that a rate cut today was also an option.
When asked about what stopped the Governing Council from cutting
rates, Mr. Trichet said that the risks to price stability have not
disappeared. This is also in the Statement, which includes nonetheless
an important change in this respect: “upside risks to price stability have
diminished somewhat, but not disappeared”, instead of “risks to price EMU: 3-month interest rates
(Euribor future contract and BBVA forecast)
stability over the medium term prevail” from last month. Mr. Trichet was 5.5 5.5
also inquired about the predictability of the Council actions, and replied
that any action would be taken at any time to ensure the achievement of 5 5
the ECB’s objectives. To us this is a clear sign that the ECB could cut
rates even outside standard meetings, if necessary. 4.5 4.5
4 4
Regarding economic activity, the statement emphasises the
“extraordinary high degree of uncertainty” due to the financial market market - 2 oct
3.5 3.5
turmoil and the evidence from recent data that economic activity is market - 1 oct
weakening. Mr Trichet said that a similar situation was never seen before 3 3
1t08
2t08
3t08
4t08
1t09
2t09
(in the history of the ECB). The statement also considers that the
economic outlook is “subject to increased downside risks”. A gradual
recovery in now expected in the course of 2009. But when asked if the Source: Bloomberg and BBVA
ECB maintains its view that the recovery would start as from the last
quarter of 2008, Mr Trichet implicitly recognized that the outlook has

2. worsened by reminding us that they always said that after the trough
in the second and third quarter of this year the risks to activity were
downwards.
On the reasons of why inflation risks have moderated, the statement
includes the relative decline in energy and commodities prices
experienced recently. Moreover, and this is new, the weakening in
demand is expected to help bring inflation in the euro area close to
the ECB target. Regarding the possibility of second-round effects,
the Statement emphasizes the acceleration of unit labour costs in
the second quarter. With respect to monetary developments, the
statement repeats comments on some relative moderation of broad
money and credit aggregates, albeit data does not include the
recent events in financial markets.
Mr. Trichet was repeatedly asked about the rescue measures on
troubled financial institutions in some Euro Area countries. Overall,
he supported them, without being explicit on the pertinence of an
Euro area-wide plan, but pointing out that the current institutional
arrangement leaves the responsibility on the individual
governments.
In the conclucion of the statement, the key sentence saying “the
current monetary policy stance will contribute to achieving our
objective” has been remove.
Markets’ reaction: The euro fell from 1.391 to 1.375 against the
dolar, while the Eonia future markets discount a 25bp rate reduction
with a probability of 75%.
Concluding remarks
In front of increased evidence of deteriorating activity and (mostly) of
very high stress in financial markets, the ECB has not disappointed
and has clearly changed its tune from a hawkish to a pre-cut mode.
Although the justification is disguised as higher downward risks to
growth and lower upward risks to inflation, these have not changed
enormously in our view, and the real reason lies in that risks from
financial developments, which the ECB did not emphasize before but
are now bluntly in front of us.
Our forecast is for current tensions not to disappear in the short run,
so we foresee a rate cut in November, although it could well be
earlier in a snap decision if financial conditions deteriorate further, or
could be delayed until December. We further expect four additional
cuts in the course of 2009, down to 3% (instead of 3.25% in our
previous forecast).
Servicio de Estudios Económicos 2

3. Box: ECB Statements
rd th th nd Concluding
July 3 August 7 September 4 October 2
remarks*
The Governing Council It remains imperative to
remains strongly avoid second-round The Governing Council
The Governing Council
committed to effects and in price and discussed extensively the
will monitor very closely
preventing second- wage-setting. The recent intensification of
all developments over the
round effects and the Governing Council is the financial turmoil and
Monetary period ahead. It remains
materialisation of resolute in their its possible impact on Ready to act at
policy crucial to avoid second-
upside risks to price determination to keep economic activity and any time
stance round effects and to
stability over the medium inflation expectations inflation. They will
keep inflation
term. We will continue to firmly anchored and it continue to monitor
expectations firmly
monitor very closely all will monitor very closely very closely all
anchored.
developments over the all developments over the developments.
coming weeks period ahead.
The real GDP growth
figures for mid-2008 will The euro area economy
The most recent data
The uncertainty be substantially weaker, is currently
clearly confirm that
surrounding this but this represents a experiencing an
economic activity in the
outlook for economic technical reaction to the episode of weak activity
euro area is weakening.
growth remains high strong growth in Q1. The characterized by high
The economic outlook is
and downside risks uncertainty commodities prices Increased
subject to increased
continue to relate to the surrounding this weighing on consumer downside risks
Growth downside risks due to a
potential for the outlook for economic confidence and demand, due to financial
scenario on ongoing
ongoing financial activity remains high as well as by dampened turmoil.
financial market
market tensions to affect and the downside risks investment growth. The
tensions affecting the
the real economy more continue to relate to the Governing Council
real economy more
adversely than potential for the expects this episode to
adversely than currently
anticipated. financial market be followed by a
foreseen.
tensions to affect the gradual recovery.
real economy.
Likely to remain well
above 2% for quite Likely to remain well Likely to remain well
Likely to remain well
some time, moderating above 2% for quite above 2% for some
above 2% for quite
only gradually in 2009 some time, moderating time, moderating
some time, moderating
and likely to be more only gradually in 2009. gradually during the
only gradually in 2009.
persistent. Imperative The Governing Council is course of 2009. The Gradually
Inflation It is imperative to ensure
that they do not monitoring price-setting Governing Council is moderation
that medium and long-
become entrenched in behaviour and wage monitoring price-setting
term inflation
longer-term negotiations in the euro behaviour and wage
expectations remain
expectations or lead to area with particular negotiations with
firmly anchored.
broadly based second- attention. particular attention.
round effects
Upside risks to price
Clearly on the upside. Clearly on the upside. Clearly on the upside. stability have diminished
These risks include the These risks include the These risks include the somewhat due to the
possibility of further possibility of further possibility of renewed weakening in demand.
rises in energy and rises in energy and rises in commodity Risks do not disappear:
food prices … in food prices … in prices … in the possibility of renewed
Upside risks are
Risks administered prices and administered prices and administered prices and increase in commodity
diminishing
indirect taxes... Most indirect taxes... Most indirect taxes... Most prices, in administered
importantly, price and importantly, price and importantly, price and prices and indirect
wage-setting behaviour wage-setting behaviour wage-setting behaviour taxes. Very strong
could add to inflationary could add to inflationary could add to inflationary concern about price
pressures pressures pressures. and wage-setting
behaviour.
Confirms the prevailing Confirms the prevailing The still strong
Confirms the prevailing upside risks to price upside risks to price underlying pace of
Strong
upside risks to price stability at medium to stability at medium to monetary expansion
underlying pace
stability at medium to longer-term horizons. longer-term horizons. The points to upside risks
of monetary
longer-term horizons. While the growth of broad growth of broad money over the medium term,
expansion, but it
Underlying rate of money money and credit and credit aggregates although the growth of
Monetary is moderating;
and credit growth remains aggregates is showing continue to show some broad money and credit
analysis no significant
strong. The availability of some signs of signs of moderation. The aggregates moderated.
impact from
bank credits has not been moderation, the strong strong underlying pace of The availability of bank
ongoing
significantly affected by underlying pace of monetary expansion credit has, as yet, not
financial
the tensions in financial monetary points to points to continued been significantly affected
tensions
markets. continued risks to price upside risks to price by the ongoing financial
stability. stability. tensions.
Movement 0.25 0.0 0.0 0.0
“Refi” rate 4.25 4.25 4.25 4.25
* BBVA interpretation of the ECB opinion according the statement and the press conference
Servicio de Estudios Económicos 3

4. Relevant events before the next ECB meeting (November 6th)
October, 14 Euro Area industrial production, August
October, 15 Euro Area inflation, September
October, 17 Euro Area trade balance, August
October, 17 Euro Area construction output, August
October, 23 Euro Area industrial new orders, August
October, 28 Euro Area money supply (M3), September
October, 30 Euro Area business and consumer survey, October
October, 31 Euro Area flash estimate inflation, October
October, 31 Euro Area unemployment rate, September
November, 3 Euro Area PMI survey, October
November, 4 Euro Area producer prices, September
Servicio de Estudios Económicos 4