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TD Economics
Commentary
January 15, 2009
ECB CUTS, THEN SHUFFLES TO THE SIDELINE
The European Central Bank cut the main refinancing
rate for the fourth month in a row, bringing the level to
2.00%. This was in line with market expectations, and,
while we believed there was a large chance for the ECB
to cut less than what they did, the disappointment was de-
livered during the post-decision press conference instead.
There, President Trichet reiterated the Governing Coun-
cil’s expectation that the level of inflation will be in line
with price stability over the medium-term. However, they
now see the risks to that expectation to be “broadly bal-
anced,” rather than just “more balanced” as they did in
December. Moreover, President Trichet signaled that with
the February meeting coming in just three weeks, there is
likely to be no meaningful change in the Governing Coun-
cil’s sentiment until March at the earliest. While we be-
lieve the ECB will ultimately need to lower rates 50-
75 basis points from here, this will likely not come
until the April to June period, as the evidence mounts
for the ECB that the economic weakness in the
Eurozone will linger into the latter half of the year.
In making its decision, President Trichet made it clear
that the decision today was made not only on the basis of
existing weakness, but the expectation that significant eco-
nomic weakness will persist in the “coming quarters.”
Moreover, he cautioned markets that near-term sharp de-
celeration in inflation is relatively insignificant from a mon-
etary policy perspective. Instead, markets should focus
on the fact that Eurozone inflation may see a sharp re-
bound in the latter half of the year. It is developments in
this factor that will drive ECB decisions in the coming
months.
Our expectation is for an ongoing contraction in the
Eurozone economy in the first half 2008, a sluggish accel-
eration late in the year, and oil prices troughing near $30 by
the middle of this year. We believe this profile will give the
TD Economics Commentary
EUROZONE CONSUMER PRICE FORECASTS
5
Y/Y %
5
Actual (black)
4
TD Economics
4
model (green)
Oil gradually
3 3
rises to $60pb
by year end
2 2
Oil remains
at $40
1 1
0 0
Oil falls to $20pb by
May and stays there
-1 -1
01/07 05/07 09/07 01/08 05/08 09/08 01/09 05/09 09/09 01/10
*Forecasts by TD Economics as of January 2009
Source: Eurostat and Haver Analytics
ECB further room to cut rates, but it will take time for this
expectation to firm. The two key factors to watch go-
ing forward to gauge the ECB’s bias will be Eurozone
consumers and energy prices. The ECB’s expectation
is that part of the recovery will be driven by consumers
and their increased purchasing power driven by lower fuel
prices. If this fails to materialize – and we believe credit
tightness will inhibit consumer spending – then the ECB
will need to revise their expectations for GDP growth lower.
Second, given our sour economic sentiment, our models
suggest that oil prices near $40 for 2009 (February-De-
cember) would be the level needed to drive inflation back
to the 1.5%-2.0% level by year-end. Therefore, oil prices
approaching $30 would help free the ECB’s hand to cut,
while oil prices above $40 would likely drive the ECB to
remain more hawkish.
Richard Kelly, Senior Economist
416 982 2559
January 15, 2009
 www.td.com/economics

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TD Economics Commentary January 15, 2009