Analyst Interview: David Song On Portugal, The ECB, The Fed And ZIRP

By David Song, Currency Analyst

• Do you think that a potential Greek default will cause Portugal, at present rated junk by all three of the major rating agencies, to default as well?

A Greek default would certainly rattle investor confidence, but will have little influence in pushing Portugal to default on its debt as the European Central Bank continues to shore up the financial system. The ECB’s LTRO has helped to alleviate funding costs for Portugal and conditions should improve further as the central bank prepares to launch its second unlimited three-year loan facility at the end of the month. In turn, the efforts should help Portugal to meet its debt obligations and the region should be able to tap the bond market over the medium-term as the government takes extraordinary steps to balance public finances.

• What is the chance of the ECB performing another interest rate cut by 25 bps at the upcoming meeting, such as it was hinted by Draghi? Has the situation in the Eurozone improved enough for the central bank to refrain from a cut for now?

There’s a good chance of seeing another 25bp rate cut by European Central Bank President Mario Draghi as the euro-area remains at risk of a major economic downturn in 2012. In turn, we may see the Governing Council carry its easing cycle into the second-half of the year as subdued growth dampens the outlook for inflation. As the ECB maintains it’s one and only mandate to preserve price stability; the disinflationary environment may encourage Mr. Draghi to maintain a dovish tone for monetary policy and the central bank head may weigh additional measures to shore up the ailing economy as the fundamental outlook for the region remains clouded with high uncertainty.

• Will recent, weaker than expected US economic data induce the Fed to introduce QE3 in the first quarter of 2012?

Although the Fed continues to highlight the ongoing slack within the economy, the central bank has limited scope to expand its balance sheet further as the risk of a double-dip recession subsides. As Fed officials expect to see a more robust recovery in 2012, the stickiness in the core rate of inflation could spur a growing rift within the central bank and we may see the FOMC stick to its wait-and-see approach throughout the first-half of the year as private sector activity gradually gathers pace.