Daily analyst comments

On July 2, the European Central Bank decided to leave its benchmark interest rate unchanged at 1%. The ECB base interest rate has been lowered in a series of seven cuts since October 2008 by a total of 3.25%.

According to the ECB president, Jean-Claude Trichet, the current interest rate suits the economic environment, and the bank does not plan to lower its base rate in the near future. The ECB expects that the Eurozone economy will begin to recover in mid-2010. Trichet believes that the European economy might have already passed through the worst part of the economic recession; however, the Eurozone economy is likely to stay weak in the next few months.

Inflation in the Eurozone is currently falling: for example, in May, the inflation rate fell to 0%, and in June, in accordance with preliminary estimates, Europe even saw a 0.1% deflation. The ECB believes that deflation might have been due to the low-base effect related to high commodity prices last year. Prices may continue to deflate in the next few months. The target inflation rate for the mid-term is set at 2%, and as the macroeconomic climate improves, the ECB will be ready to quickly absorb excess liquidity.

The Forex market showed a sharply negative response to the ECB decision to keep its benchmark interest rate low as it has confirmed the weakness of the European economy. We note that the ECB adheres to a more conservative policy than other large central banks. On one hand, this could somewhat delay the process of economic revival. On the other hand, such a decision implies lower inflationary risks, which should positively affect the Eurozone economy in the long-term. We also note the ECB’s readiness to quickly absorb liquidity as the economic climate improves, in on order to prevent inflation.