ECB Preview

November 7, 2012

A policy change is not anticipated.  The ECB announces its interest rate decision at 12:45 GMT, and Pdt Draghi’s press conference begins at 13:30 GMT.

Draghi’s introductory statement from October 4 was not very illuminating, and many believe that has been by design.  Key details surrounding the OMT facility (outright monetary transactions) have been kept under wraps.  What is known is that conditions for using the facility have not been met.  While that didn’t prevent peripheral bond yields versus Germany from moving sharply inward, most of the improvement since Draghi declared the euro irreversible in a Le Munde interview in July had occurred by the time of the October meeting.  The Spanish-minus-German 10-year differential, for example, was 610 basis points wide on July 20, 420 bps on October 3, and 421 bps on November 6.  Greece has been somewhat of an exception; it’s differential versus Germany narrowed from 1,671 bps on October 3 to !,581 bps on November 6.

ECB officials have provided only some very broad guidelines.  If peripheral governments fully meet stringent reform and other conditions, they will be eligible to use the OMT in an unlimited way provided they continue to fully accept all conditions during the period of their OMT usage.  Draghi has underscored that the future use of OMT hinges on what the governments now do.  Markets are likely to learn little more from this month’s statement or tomorrow’s press conference.

Other forms of stimulus do not seem likely tomorrow, either.  Officials in October were strongly hesitant about cutting interest rates further before policy transmission is fixed, a condition that still hasn’t been sufficiently met.  A rate change was not even discussed in October.  Euro area GDP fell 0.7% annualized in 2Q12 but may have been steady to marginally higher last quarter.  Fourth quarter is shaping up to a likely contraction, but not enough information on that matter is available to act yet.  Doing another LTRO at this juncture would probably carry more risk (like the wrath of the Bundesbank) than potential reward.  OMT is to be the vanguard of unconventional policy efforts to ensure a single monetary policy that has similar effect on all EMU members.  Other unconventional actions at this point would distract attention from the OMT.  Such might even stiffen Spain’s resistance to requesting a conditional aid package.

Euroland’s economy is far from a road to sustained recovery.  The composite purchasing managers index covering both services and manufacturing in October was 45.7, lowest since mid-2009.  The euro group’s index of leading economic indicators fell 0.4% in September, while the coincident index stalled.  Two major problems loom.  One is that weakness is seeping into Germany, which would presumably need to be a locomotive for the region while the peripherals experience their own fiscal cliff.  German industrial orders plunged 3.3% in September and 4.7% from a year earlier.  Industrial production in Germany dropped 1.8% between August and September and, like orders, was much weaker than analysts assumed.  The second concern is that almost every country whose government has imposed fiscal austerity has drowned in its self-imposed downturn before successfully swimming on through to the other side.  Draghi’s claim that the euro is irreversible only works if the weak links in the chain can recoup competitiveness.  If that doesn’t happen, markets will see the ECB’s assertions as coming from an emperor with no clothes.

The ECB’s strategy of moving to the sidelines works if the global and regional economic and psychological landscape is constructive.  For months, investors have looked eagerly to America’s election so that a key uncertainty would at least be removed.  Alas, this may be a case of being careful about what you desire.  Four years ago when Barack Obama was first elected on November 4, the Dow Jones Industrials Average plunged 486 points or 5.0% on November 5.  It dropped 8.8% by yearend and 32.0% before bottoming in early March 2009.  From November 4 to that point, the German Dax fell 26.4%, underscoring the interdependence of all global markets. 

If U.S. financial markets now turn volatile, Europe is unlikely to be insulated especially given the fragility of its economy.  And if in that maelstrom, policymakers at the ECB still want to have a purpose and future, it will not be possible for them to maintain a nonpolitical stance of having proposed a framework that might work but that will be used only if government leaders fulfill their responsibilities.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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