ECB Preview: Conference Poses Risks for Euro

March 3, 2010

No chance exists of a change in ECB interest rates.  A 0.25% deposit rate and 1.75% marginal lending rate flank the 1.0% refinancing rate.

New staff forecasts will be unveiled for growth and inflation, and further steps in the dismantling of market-supporting liquidity enhancements are due to be announced.  In December, projected growth in 2010 was revised upward from a range of minus 0.5% to plus 0.9% to a range of +0.1-1.5%, and projected GDP in 2011 was penciled in initially at +0.2 to 2.2%.   Those are unlikely to get lifted this time.  In December projected CPI inflation was revised up by a tenth to a range of 0.9% to 1.7% in 2010.  Inflation next year was centered at 1.4%, about a half-percent below target.  These price forecasts may get revised downward.  Six to eight weeks ago, the market focus would have been on the exit from quantitative credit support and what such might imply about the timing of an initial increase of the refinancing rate.  The mind-set of investors is on other matters now.

ECB President Trichet has previously taken a tough-love view on Greece, a country that comprises just 2.7% of Euroland GDP.  Even at that size, Greece is too big to fail, because waiting in the wings are Spain (11.6% of Ezone GDP) and Italy (17.1%).  Greece seems to have slipped into a double-dip recession with a PMI-manufacturing reading at a 10-month low.  Spain never escaped its downturn, which deepened last month.

Growth in Euroland has become more diverse and overall practically stalled last quarter, when GDP firmed 0.4% at an annualized rate.  As a result, growth in 2009 fell more than thought, a drop of 4.0% after an increase of just 0.6% in 2008.  All that means the region has more spare capacity, which in combination with very low growth in M3 (minus 0.1% on year in November-January) and private loans (down 0.6% in the year to January) points to more deflationary pressure in the future than ECB officials have cared to acknowledge previously.  In fact, consumer price inflation in the bloc was only 1.0% in January, and core edged down a tenth to 0.9%, half its rise in the previous 12 months.  There’s more.  The bellwether German I.G. Metall labor settlement implies wage gains of just 1.5% per annum and less than 1.0% if adjusted for inflation, which is the weakest award in three decades.  Consumer and investor confidence are looking flimsier.

In the real economy, industrial production slumped 1.7% in December, and retail sales in January were 0.2% lower than their 4Q level after having dropped 0.8% annualized in the fourth quarter.  The brightest ray of hope can be found in the economic sentiment data series, which printed at 95.9 in February and 96.0 in January versus a monthly average of 91.4 in the fourth quarter.  The readings over the past two months suggest that economic growth re-accelerated in the present quarter and could reach 0.4% not annualized.

The ECB announcement on Thursday will be at 12:45 GMT and be followed by a press conference at 13:30 GMT.  In the past, Trichet has accentuated the positive and reminded everyone that the present policy can’t go on forever and that containing inflation and expected inflation are the primary objectives.  The whole tone of such remarks have been euro-supportive.  Some of that pretense can be dropped.  Deflationary risks now loom larger than inflationary ones, even if the baseline forecasts change little.  In such an environment, a little more euro depreciation probably does more good than harm.  The euro is still slightly more than 15% above its lifetime average dollar level, so the level of the euro, as opposed to its rate of change, offers no reason to be especially worried.  With greater impetus on Euroland’s fiscal offenders to double up on austerity, euro depreciation would offer a welcome growth counter-weight.

It would not be surprising if this week’s press conference takes on a more dovish tone than prior ones, and that would likely have an immediate adverse effect on the euro, unless investors choose to wait for what comes out of Friday’s talks between the German and Greek political leaders.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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