So The ECB Will Cut Rates, Why Is That?

You remember about the image of this big locomotive that has had it engine cut while giving the impression of moving... well it's now clearly stopping and fast.

This locomotive can be the world, the European or Finnish economy, it's all the same as all are coupled. Commodities are on free fall since the locomotive is about to slow dramatically, so not any more needing energy.

The Euro is collapsing after Jean-Claude Trichet, the ECB president clearly said that Europe is slowing and the second half could see further deterioration. Inflation is not a threat as people will bargain not to be fired instead of a salary rise, the window of opportunitty has passed... Asset price increase (any real estate) is not a threat either as it has started its cyclical downturn. Retail sales are surviving only by providing huge sales to consumers that are not willing to spend since burden by debt.

So the ECB will cut rate as I highlighted in this chart, it will start cutting rates at best in the third quarter as early as September if the data deteriorate faster or beginning of next year to make sure that threat of second round effect doesn't occur. Rates will be cut until 2010 to 3% in order to stabilise the economy. Of course rates could go much lower if special event happen such as escalating Russian war or an attack agains Iran.

Obviously, data could change in both direction delaying either a rate cut or even triggering a rate increase, today the world is probably impredictable. it's like an addict that took to much of the credit drug, its reaction can be quite erratic, but the best will be to send it to rehabilitation for a while, to bring it back to a normal state...

Today it feels better for the one who foresaw the craziness in the run up of this real estate frenzy and bank lending binge. Having debt is fine in good times, but a very wrong choice in bad times, in a deflationnary and a deteriorating geopolitical environment.

Talking about Geopolitical tensions, if the Russian-Georgian conflict spread or impact the energy supply balance then oil could rally again, deepening futher the economic dowturn. If at the same time social partners and Union decided to bargain higher wage in order to compensate lost purchasing power then interest rates will shoot up.

As Mr Trichet said in his press conference last thursday, a clear warning that second round effect will not happen :

"Moreover, employment and labour force participation have increased significantly, and unemployment rates remain low in historical terms. However, these developments, which support household disposable income and consumption, are unlikely to fully compensate the loss of purchasing power caused by higher energy and food prices. "