ECB Preview

December 1, 2010

Thursday’s ECB press conference is atypically significant for a variety of reasons.  These events used to be all about what refinancing rate officials would announce.  That’s the easy part.  The rate has been at 1.0% since May 2009 and will not change tomorrow.

Officials will update their growth and price forecasts for 2010 and 2011 and introduce projections for 2012.  The December meeting of the ECB’s ideological ancestor, the German Bundesbank, was always the most eagerly awaited meeting of the year because of the unveiling of new money growth targets and the assumptions upon which such was based.  Money and credit growth influence ECB policy not as a mechanistic target wherein deviations require policy adjustments but rather as one of two broad informational pillars around which policy decisions are to be framed.  The ECB targets total CPI inflation, and the projections for the new out-year 2012 will be consistent with the target that CPI inflation lie below, but close to, 2%.  Analysts expect growth forecasts to be bumped slightly higher.  The evolution of ECB forecasts, which get revised quarterly, is presented below.  Each row in the table shows the forecasts unveiled in the month indicated in the left-most column.

  GDP ’09 GDP ’10 GDP ’11 CPI ’09 CPI ’10 CPI ’11
09/10   +1.4/+1.8% +0.5/+2.3%   +1.5/1.7% +1.2/2.2%
06/10   +0.7/1.3% +0.2/2.2%   +1.4/1.6% +0.2/2.2%
03/10   +0.4/1.2% +0.5/2.5%   +0.8/1.6% +0.9/2.1%
12/09 -4.1/-3.9% +0.1/0.5% +0.2/2.2% +0.3% +0.9/1.7% +0.8/2.0%
09/09 -4.4/-3.8% -0.5/+0.9%   +0.2/0.6% +0.8/1.6%  
06/09 -5.1/-4.1% -1.0/+0.4%   +0.1/0.5% +0.6/1.4%  
03/09 -3.2/-2.2% -0.7/+0.7%   +0.1/0.7% +0.6/1.4%  
12/08 -1.0/0.0% +0.5/1.0%   +1.1/1.7% +1.5/2.1%  
09/08 +0.6/0.8%     +2.3/2.9%    
06/08 +1.0/2.0%     +1.8/3.0%    
03/08 +1.3/2.3%     +1.5/2.7%    
12/07 +1.6/2.6%     +1.2/2.4%    


Economic data since the last meeting on November 4 support the ECB’s view that an economic recovery with moderate inflation will be able to continue.  There have been disappointments, to be sure.  Latest month-on-month drops of 0.9% in industrial production, 0.2% in real retail sales, and 3.8% in industrial orders were three of them.  But sentiment continues to improve.  The ZEW index of investor perceptions improved 12 points to 13.8 last month.  Overall economic sentiment reached 105.3 in November, three points higher than in August.  Over those three months, consumer confidence rose two points, and industrial-sector sentiment went up 3.8 points.  The composite preliminary purchasing managers index for the euro area was 55.4 in November, up from 53.8 in October and 54.1 in September.  GDP advanced 1.5% annualized last quarter and by 1.9% between 3Q09 and 3Q10.  Growth in M3 of 1.1% and private bank loans of 1.4% remains very low but is edging up with the implication that low inflation will be preserved in the medium term but not degenerate into deflation. 

ECB Governing Council members are meeting at a do-or-die juncture for the European Monetary Union.  The macroeconomic figures do not reveal a sense of crisis, and a break-up of the union does not seem imminent, since the costs for any nation contemplating that route remain greater than the costs of staying in the fold.  However, the cost/benefit balance for decisions to stay an EMU member of to leave is not fixed but rather contingent upon market behavior.  It was not the intention of the last British Conservative government to take sterling out of the ERM, but market forces changed the cost/benefit equation and made the unthinkable happen.  It will be much harder for a member of the Monetary Union (EMU) to bail out than it was for countries participating in the old Exchange Rate Mechanism (ERM).   The wounds on the transgressor will be economic this time rather than a blow to national pride.  Defection has been made harder.  But impossible?  Not really. 

Thus far, ECB President Trichet’s press conferences have stood above the political fiasco gripping EMU, but that stance will become harder to maintain.  The central bank has forcefully endorsed the imperative of fiscal consolidation and abiding by the letter of a tightened pact to ensure fiscal compatibility.  Trichet has helped to alleviate the pain of the debt crisis, buying long-term debt assets of the peripheral countries in hopes of countering upward pressure on their yields.  But he continues to stress that a firewall exists between efforts to direct liquidity to the market through unconventional measures and the stability-oriented monetary policy that seeks to anchor expected inflation and to achieve medium-term inflation consistent with the target.  Liquidity enhancements at the short and long ends of the market are being sterilized.  The ECB does not want to put itself in the center of a political crisis, and that could happen easily with an errant insinuation at a monthly press conference.  The late Wim Duisenberg, the first ECB president and Trichet’s predecessor, had a habit of occasional slips of the tongue that moved the market in undesirable ways.  With Trichet, little gets said that’s not premeditated and carefully thought out in advance.  A time may come when he’ll need to take greater risk with what he says.

Regional governments have muddled their way through a relentless crisis, reacting to market developments rather than getting ahead of the crisis with a convincing integration of fiscal policies.  A crisis that could have been stopped at Greece has instead spread grindingly but relentlessly toward bigger EMU members like Spain and behind that Italy or even France.  From a stability point of view, the ECB wants to proceed with an exit strategy to phase out unconventional measures.  It has already backtracked on the exit timetable but because of heightened global uncertainties.  It may have to do so now because of heightened regional uncertainties.  How that connection is expressed should longer-term refinancing operations be extended may have a profound impact on the evolution of the crisis itself.  Trichet will want to clarify as little as possible but at the same time reassure investors that ECB policy remains flexible to the needs of the moment.  He will have to bring is best diplomatic game to tomorrow’s press conference.

Compared to when the ECB Council last met, the 1-day interbank interest rate for the Euro zone, also known by the acronym of EONIA, is up eight basis points at 0.54% but well below the central bank refinancing rate of 1.0%.  Ten-year bund yields have climbed 36 basis points to 2.78%, and the bond yield premiums of  other EMU members versus Germany have widened further even after a EUR 85 billion rescue package for Ireland was negotiated.  The euro was as strong as $1.4239 on November 4 but is now 7.7% weaker at $1.3139.

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



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