An Important ECB Press Conference Tomorrow

March 2, 2011

The ECB will not raise its 1.0% refinancing rate tomorrow, nor modify the deposit rate and marginal lending rate that symmetrically flank it at 0.25% and 1.75%.  A signal of an imminent tightening next month also seems doubtful.  The last rate change was made in May 2009.  Officials are expected to upgrade the inflation risk assessment and to unveil restraints on banks that are habitual users of facilities of enhanced liquidity.  It’s a close call whether three-month unlimited refinancing auctions at a fixed 1.0% will be extended to midyear; I’m leaning toward the view that those auctions will become more restrictive.

The press conferences in March, June, September, and December generally convey more information than others because those are the months when the ECB staff updates its price and growth forecasts.  The growth forecasts from December 2010 had midpoints of 1.4% and 1.7% for growth in 2011 and 2012 and of 1.8% and 1.5% for CPI inflation in those years.  All of these projections will likely get bumped higher.  It could be argued from forward-looking data that the economy is on a stronger recovery path than assumed, so its risk assessment could shift, too. 

  • Industrial orders expanded 9.8% annualized last quarter and were 2.1% greater in December than their 4Q10 average level.
  • Business sentiment advanced another whole point in February to 107.8, with improvements in all categories.
  • The manufacturing purchasing managers survey reading of 59.0 in February was the highest since June 2000 and above January’s 57.3 or the average 4Q score of 55.4.  Such levels depict an economy that’s doing better than a moderate pace of growth.
  • Euroland’s flash services PMI was 57.2 last month after 55.9 in January and a 4Q mean of 54.3.
  • Yet all cylinders are not firing: real retail sales fell 2.3% at an annualized pace last quarter, the current account deficit widened to EUR 33.3 billion in 4Q from EUR 14.3 billion in 3Q10, and the spike in world oil prices constitutes a drag that has not yet impacted reported data.  The downwardly skewed growth risk assessment from February therefore may be left as such, but it also could get raised to “balanced.”

There’s little doubt, however, that the “balanced” inflation risk assessment will be upgraded to upwardly skewed.  CPI inflation of 2.4% according to the preliminary February indication was up from 2.3% in January, 2.2% in December and 1.9% in November.  Core inflation of 1.2% in January compares to 0.8% a year earlier.  In spite of a well-bid euro, producer price inflation has accelerated from a 12-month increase of 3.6% in August to 6.1% in January, including a rise in non-energy items to 3.9% from 2.3%. Unemployment has dipped to 9.9%, breaking below double digits for only the second month since late 2009.  A slew of surveys confirm that input inflation is at the most intense level in several years.

Like other central banks, the ECB uses jargon to convey a sense of timing in its policy changes.  When it wants to signal that a change at the following meeting has distinct possibility, it conspicuously deletes calling present policy “appropriate” and has trotted out the expression “strong vigilance.”  In February, as before, the stance was called accommodative but appropriate.  A change in that expression would elicit a substantial market reaction.  Analysts differ over whether the ECB’s first rate hike happens at midyear, in the third quarter, the fourth quarter or next year, but nobody seems to be flagging April yet.  Other clues to look for are what is said about expected inflation.  Officials have repeatedly said such indications are in line with its medium-term target of “below but close to 2%,” and money and credit growth remain subdued, a factor officials have consistently associated with contained inflationary pressure over the medium to long term.  Finally, investors will want to see the 2012 projected inflation midpoint at 2.0% or higher before concluding that the rate hike trigger is about to get pulled.

ECB President Trichet, who retires in October, has stressed repeatedly a separation principle between the basic monetary policy that’s oriented toward securing price stability, which is done by setting appropriate interest rate levels, and its unconventional liquidity-enhancing steps, which are intended to facilitate proper market functionality, so that the typical response of growth and prices happens to central bank interest rates.  Officials have not been able to close down unconventional policy initiatives as smoothly or as soon as they hoped initially.  One step that makes sense given the upbeat tone of data and firmness of the euro would be a modification of the terms of three-month refinancing auctions in the second quarter.  Another is to place restraints on banks that appear to be over-using the unconventional facilities.  Action in both of these respects seems likely to be taken tomorrow.

When the ECB Governing Council met last December and four weeks ago, the euro was trading respectively at $1.317 and $1.376 versus $1.387 now.  The ten-year German bund yield was at 2.78% in December and 3.26% a month ago versus 3.20% currently.  And WTI crude oil has risen from $88 when officials met in December to $90.50 at the time of the February meeting and $101.73 at present.  The Fed sees oil price spikes as foremost a threat to growth and therefore disinflationary in the medium run.  Traditionally, Europeans choose to fight the immediate price risk posed by rapidly rising commodity costs when and as such arise if there is any evidence or strong presumption of second-order inflation taking hold.

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



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