ECB Preview: Euro weakness relieves Draghi of the need to act
06-Nov-2013
Bottom line: I expect a rather subdued European Central Bank (ECB) meeting without much new information from its president, Mario Draghi. The recent euro weakness relieves Draghi of the need to take action, verbal or otherwise. No rate cut is expected.
Details: Just a week or two ago the chances of a rate cut did not seem remote as the single currency climbed relentlessly against the US dollar. The expectation was that a cut would come if not at Thursday's meeting then at least in December. Since then the euro has slumped 2.5 percent from its October 25 high, and even verbal intervention by Mario Draghi at the press conference may not be deemed necessary. If only inflation would behave, that is. For while the euro has indeed weakened (1.6 percent trade-weighted in just a week) the September inflation report did little to remove the concerns about disinflation -- or even outright deflation. Headline inflation dropped to just 0.7 percent (the lowest since November 2009) from 1.1 percent prior while core inflation hit 0.8 percent from one percent. Despite the disinflationary tendencies, I do not expect either a rate cut or much in terms of verbal intervention at this month's ECB meeting.
Inflation may have weakened in recent months, but temporary factors especially related to energy and a strong euro are part of the explanation. The ECB will be aware of this as the ECB president clarified at the October meeting: "On the basis of current futures prices for energy, annual inflation rates are expected to remain at such low levels in the coming months. Taking the appropriate medium-term perspective, underlying price pressures are expected to remain subdued, reflecting the broad-based weakness in aggregate demand and the modest pace of the recovery."
Euro area data has not changed meaningfully since the October meeting when Mario Draghi said the following of the economy: "We view the recovery -- and I said this last time and I continue to have basically the same view -- as weak, as fragile, as uneven, and that certainly also contributes to the outlook for price stability." The monthly aggregate indicator Eurocoin, which is a proxy for monthly activity, climbed to 0.2 in October (based on data so far available) from 0.12 in September, the highest reading since 2011. PMIs were also more or less unchanged last month with the composite easing to 51.9 from 52.2, a fourth month in a row above the 50 threshold.
Bank lending to the corporate sector declines at a reduced pace according to the September report and household lending rose 0.1 percent following three months with unchanged annual lending growth. Loans to non-financials dropped 3.5 percent in the twelve months through September compared with a drop of 3.8 percent in August. Lending activity is a lagging indicator and should improve in the coming quarters.
The euro is not strong enough to warrant action, in particular given the last two weeks' decline, which has all but erased the gains in the trade-weighted euro index since the October 2 ECB meeting. It now stands just 0.1 percent above that level compared with October 29 when it had gained 1.7 percent; no doubt helped by expectations of ECB action. The strength in the euro is comparable to February when the strength was acknowledged, but the subsequent weakness saw the ECB refrain from action. Furthermore, data -- as mentioned above -- has not weakened despite the strong euro.
Based on the above I expect an ECB meeting which does not result in a cut to the main refinancing rate, currently standing at 0.5 percent. Furthermore, Mario Draghi is expected to reiterate the party line at the subsequent press conference, namely that the ECB accepts the low-running inflation of the moment. However, given the weakness in the headline HICP figure (0.7 percent) a step up in rhetoric is likely with Draghi emphasising that the ECB is monitoring the situation closely and stands ready to act. Currently three brave souls out of 70 analysts interviewed by Bloomberg expect a cut in the refi rate to 0.25 percent, the rest expect no change. For another ECB preview see Juhani Huopainen's post
--Edited by Clare MacCarthy |
