SNB announces another inter-meeting cut of 100bp: targets the 3mth Libor rate in a range of 0.5-1.5%, implying that it might need to resort to quantitative easing: implications for the ECB

The SNB announced a second inter-meeting rate cut, lowering its benchmark 3mth Libor target range by a further 100bp to 0.5-1.5% (it already cut the target range by 50bp to a range of 1.5-2.5% on 6 November). Such inter-meeting moves are rare by the SNB, and reveal the unorthodox nature of currently practised monetary policy. Given that the overnight rate had been trading at about 0.3%, for the SNB to bring down the 3mth Libor rate to a mid-point of 1.0%, 100bp less than it was trading at, appears to require some form of quantitative easing. The SNB announced that it would offer 3mth and 6mth repos at 0.15%.

From the ECB perspective, the SNB surprise move adds to the evidence suggesting that it is likely to lower its policy rate by 75bp at the Dec4 meeting. The surprise SNB announcement will inevitably fuel speculation that the ECB might lower its policy rate again before its Dec4 meeting, though we suspect that the ECB would wish to stick as much to its procedure and therefore to engage in a full discussion at that meeting (which, as usual, will involve the detailed quarterly analysis from both the Eurosystem projections and also from the money and credit aggregates).

We should watch very carefully any comments by Eurosystem officials during the next day, since this will follow the mid-month non-policy meeting concluded earlier today (at which the Governing Council will have received the latest draft of the staff economic projections which, as we have observed the past two weeks, are likely to include a record downward revision for the real GDP projection the following year).

Now that Eonia is fully pricing in a 75bp policy rate cut on Dec4, the question will be whether officials wish to protest that ahead of that meeting - but we suspect that they will not. Mr Weber speaks today at 9:30am/14.30 GMT, so we shall watch closely whether he is willing to speak out; then, Mr Trichet speaks at the European Banking Congress in Frankfurt at 8:00am/13.00 GMT tomorrow. At the November 2005 European Banking Congress, Mr Trichet announced that the ECB was prepared to raise its policy rate, thereby kicking off the tightening cycle that began a couple of weeks later. Therefore, we shall need to watch particularly closely whether Mr Trichet makes any comments tomorrow that might reflect the mood of today's mid-month meeting and hints as to what might lie ahead.

The brief SNB statement said that it was "making use of its room for manoeuvre" and said it will "provide the Swiss franc money market with a generous and flexible supply of liquidity in order to bring the Libor down to the middle of the target range". It observed that, as a result of the decline in oil and raw material prices, "price stability will be restored sooner than expected, and inflation is likely to fall below 2% as early as the end of this year". It added: "Moreover, international economic conditions have worsened appreciably, bringing a higher risk of a marked slowdown in economic activity in Switzerland next year" and noted it "will continue to monitor closely the situation on the money and foreign exchange markets."

An important issue is how the SNB will keep the 3mth Libor rate in line with its new target range. The SNB provides whatever money market liquidity it takes to meet its 3mth Libor target and so by getting the 3mth rate to the middle of the previous range had already caused the secured tomorrow next rate to drop down to about 0.3% in Switzerland. Therefore, given such wide spreads on unsecured lending, to drive down the 3mth Libor rate another 100bp, as is implied by today's announcement, suggests that the SNB might need to engage in some new form of quantitative easing, as did the BoJ during its QEP. That said, it might also hope that during next year the very elevated Libor spreads in relation to swaps might diminish, thus lessening the need for it to provide so much liquidity.

The next scheduled speech by an SNB official, President Roth, is not until next Thursday, though we would expect some additional form of communication, eg, an interview, before then.

Julian Callow
Barclays Capital Research
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Source: Barclays Capital, London.