ECB Preview

February 1, 2011

The Governing Council holds its February meeting this Thursday, a shorter-than-typical three weeks after its prior meeting on January 13.  The more hawkish tone adopted in January will not be dropped.  A rate increase seems remote but cannot be 100 percent ruled out.  The euro economy entered 2011 with decent momentum and above-target inflation.  However, the economy is proceeding at vastly disparate speeds, and peripheral sovereign bonds carry significant premiums above bund yields.  On the ten-year maturities, these amount to 1130 basis points in the case of Greece, 600 bps in Ireland, 390 bps in Portugal, and about 225 bps in Spain.  While the Italian and Spanish premiums have narrowed around 20 bps, Ireland’s is some 50 bps wider than when the January meeting was held. 

Over these three weeks, moreover, the euro has appreciated 5.3% against the dollar and about 3.5% in trade-weighted terms.  The yield on 10-year bunds is 17 basis points higher than three weeks ago. The ECB was conspicuous last week in buying no peripheral bonds, the first no-show since October and down sharply from the volume it was doing in December.  Even if the refinancing rate is left at 1.0% as will almost surely happen, monetary conditions have tightened since the January meeting.

Released indicators over the past three weeks of activity and sentiment have been robust.  The ZEW expectations index, a gauge of investor sentiment, climbed to 25.4 in January from 15.5 in December.  Overall economic sentiment showed little change, printing at 106.5 after 106.6 in December.  The retail purchasing managers index climbed from 52.9 in December to a 56-month high of 55.8 in January, and the manufacturing PMI reading of 57.3 in January was the best since April 2010.  Based on preliminary findings, the service-sector PMI score of 55.2 was a full point better than December’s 54.2 reading.  Industrial production in November rose 1.2% in the euro area and was 1.3% higher in October-November than the average level in 3Q.  Industrial orders posted gains of 1.4% in October followed by 2.1% in November and were also 1.3% higher in October-November than in 3Q.  Construction output in January advanced 2.0%.  November’s current account deficit of EUR 11.2 billion was the largest seasonally adjusted shortfall thus far in the calendar year, but the imbalance over the past twelve months has been less than 1% of GDP.

CPI inflation in Euroland of 2.4% on year last month was up from 2.2% in November, 1.9% in November and 1.0% at the end of 2009.  The increase has been concentrated in energy.  Core inflation has been benign near 1%, and euro appreciation and unemployment of 10% should help keep such tame.  All the same, ECB President Trichet in January stressed the permanent alertness of the Governing Council against any signs of rising expected inflation.  M3 was 1.6% higher in 4Q10 than 4Q09 after a 0.1% dip between 4Q08 and 4Q09.  However, M3 over the last five years rose 6.0% per annum on average, so money and credit trends certainly do not support any thought of easing.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.



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