ECB preparing for rate cut – Citi says could be 25 or 50bps

The ECB left the official rates unchanged after today’s meeting. As a result, the upcoming weekly refi operations, settled on October 8, will be conducted at a minimum bid rate of 4.25%.
The post-meeting statement was dovish, giving the ECB the flexibility to cut rates soon. The President said that the decision to leave rates unchanged was unanimous, but that the council also discussed a rate cut.
According to the ECB’s statement, the Governing Council extensively discussed the recent extraordinarily financial market tensions and the implications on the real economy. Trichet highlighted the deterioration of economic indicators and mentioned that domestic demand is contracting (this was the first time he mentioned that). Reflecting these developments, upside risks for inflation have diminished but not disappeared. In that context, President Trichet renewed the demand on social partners and price setters to avoid second round effects. Note, that today wage talks in the German mechanical engineering sector, where IG Metall asks for an annual wage gain by 8% have started.
Citigroup analysts have recently argued that the ECB is likely to cut soon. Citi analysts now expect a rate cut in November and do not rule out that the ECB will participate in a coordinated action with other central banks before the next Governing Council meeting. At present, the key uncertainty is whether the first cut is 25bp or 50bp. A 50bp cut will be the most likely option if data continue to weaken and financial market conditions remain very strained. President Trichet highlighted the extraordinary nature of developments on financial markets, saying conditions are “unprecedented” – i.e. worse than after 9/11. Given that the ECB made cuts of both 25bp and 50bp after 9/11, and cut outside its normal policy meetings, these comments signal that the first cut could be of 25bp or 50bp (or even more), and could come before the November meeting, if events and data require. Trichet’s comments also imply that the ECB would probably be willing to participate in a coordinated rate cut, if other central banks (especially the Fed, BoE) are also ready to ease soon.
“Our base case is for rates to fall to 3% in the course of 2009,” note Citi analysts.