Trichet as dovish as he could be – Preliminary thoughts on the ECB press conference

While there were no news in interest rates, today’s ECB meeting brought about a significant change in the central bank’s stance, with the Council discussing for the first time the option of cutting rates. The decision to leave rates unchanged was unanimous, but certainly the time of the first rate cut is now very close.

The first paragraph contains a clear recognition that growth is weakening (and domestic demand actually contracting) and inflation risks are receding quickly. During the Q&A session, Trichet explicitly maintained that the ECB will deliver price stability within 18 months (by early 2010). These remarks definitely mark the adoption of an easing bias, also because Trichet refused to admit that he has no bias, contrary to what he always did at recent pressers.

Another key fact is that the sentence that the current stance will help deliver price stability has been removed from the statement. Trichet explained that by saying that we are experiencing a period of high uncertainty. This in our view means that the ECB is about to change its stance.

Clearly the ECB wants to retain a high guard on inflation risks. Actual inflation is very high, labour costs are accelerating in sympathy with slowing productivity, and the monetary analysis still deserves close attention. But these are not forward-looking statements, and when Trichet praises the recent evolution of 5-year inflation expectations and says that they have regained control of inflation expectations, he’s admitting the ECB is more relaxed on the CPI outlook.

The ECB is finally acknowledging that the credit dynamic is slowing and that may pose a further brake on the possibility to achieve at least a tentative recovery after the trough experienced in the two central quarters of 2008. In a clearer manner than in the recent past, Trichet admits also that lower growth helps reduce upside risks to inflation.

Bottom line: the ECB now has completely free hands after having removed any potential bias more or less linked to inflation. This means they can cut rates anytime from November onwards, either because of a further deterioration in the financial markets situation or because of a worsening macro outlook. The market is now fully pricing a November rate cut. On the basis of what we have just heard, we think that if the ECB wanted to cut in November, they would have been clearer on the matter (remember how direct Trichet was in June to indicate the upcoming hike). However, after today’s meeting, we are left with the belief that a rate cut by the end of the year is a virtual certainty.