ECB: Preview of Meeting on September 4

Daily Forex Fundamentals | Written by Danske Bank | Sep 03 08 12:22 GMT |

Overview: We expect the European Central Bank to hold rates unchanged. Focus is therefore on how the ECB portrays the economic situation at the press conference. We reckon that the ECB will adopt much the same tone as at the previous meeting - i.e. not to fuel market expectations of changes in rates. Thus Trichet is expected to deliver a quite neutral statement with a repeat of the key policy phrase signalling that current rates are appropriate. However, if anything, we see the chance of a slightly hawkish twist as the ECB may choose to emphasise upward risks to inflation. Historically the ECB has been particularly hawkish when inflation forecasts are raised and we expect a slight upward adjustment to the HICP inflation projections for both 2008 and 2009 in the new ECB staff projection to be presented at the meeting. Trichet is expected to stress that inflation is still very high and above the ECB's target of below 2% through to the end of 2009. At the same time a quiet sizeable downgrade of staff growth projections is on the cards for both this year and the next. We expect the Council to accentuate its assessment that the risks around these revised projections are on the upside for inflation and on the downside for activity. Finally, we expect Trichet to repeat that the ECB will do whatever it deems necessary to ensure that inflation expectations remain firmly anchored and he will advocate that the Council "has no bias". Our ECB forecast continues to be for the ECB to be on hold for the foreseeable future, balancing weak growth and high inflation. Policy bias: The key phrase in ECB's statement is: "On the basis of our current assessment, the monetary policy stance following today's decision will contribute to achieving our objective". We believe this will be repeated in tomorrow's statement and thereby signal a neutral bias for rates in the short term. Growth: At the last meeting the ECB acknowledged the weakness of the Euroland economy in the second and third quarter of this year. In Q2 Euroland GDP contracted 0.2% in part as (using the ECB wording) a technical reaction to the strong growth seen in the first months of the year but also in part due to slower expansion at the global level and dampening effects from high and volatile oil and food prices. We expect the acknowledged weakness of the economy to be reflected in the ECB staff projection for GDP growth. We expect staff projections mid-point estimates to be revised down this year from 1.8% to 1.4%, and for 2009 from 1.5% to 1.2%. Trichet is likely to mention that risks to growth are mainly on the downside (likely using the same wording as in the June statement that "downside risks prevail"). However, we expect him to be careful not to sound too dovish, to avoid fuelling expectations of rate cuts. In recent months the growth picture of the Euroland economy in general, and Germany in particular, has deteriorated. Euroland composite PMI remained almost unchanged at 48 indicating a contraction in activity. The German Ifo has fallen markedly recording the sharpest drop in any three-month period since 1973. Furthermore, the expectations index is now lower than in 2001 and it is close to the low point in 1992. Furthermore, the large and growing gap between Ifo expectations and Ifo current conditions index indicates that the German economy is slowing fast and is likely to continue to do so in the coming months. The rather pessimistic outlook is backed by "hard data"as new orders have declined in every month since end-2007. The drop since the new year is the largest recorded since 1993, thus even falling below the levels experienced during 2003 when Germany was in recession. Growth on export markets has also deteriorated - with activity also slowing in Asia and eastern Europe. This will challenge ECB's view so far of "continued robust growth in emerging economies". Inflation: Despite the spectacular decline in inflation to 3.8% in August according to the Flash estimate from 4% in the previous two months inflation continues to be worrying ECB. In the new staff projections inflation estimates are expected to be raised once more - for this year from 3.4% to 3.6% and for 2009 from 2.4% to 2.5%, spurring worries as to whether the ECB target will be met in 2009. The ECB indicator for negotiated wage increases appears to have stabilised in Q2 at a - by historical standards - relatively high level of 2.8%. ECB is increasingly worried over rising unit labour costs and the continued rather high level of inflation expectations and will keep a hawkish tone on inflation prospects. Oil prices have levelled off recently but ECB will likely find it too early to draw any conclusions from that. Monetary developments: M3 growth and credit growth has moderated recently but as year-on-year growth rates are still close to double the reference rate of 4½% this will likely not be enough for the ECB to change its medium term concern over the "money gap"that has been building up in recent years (M3 growth has not been close to the reference rate since 2003). Hence we don't expect any changed signals on this pillar. Selected comments made by members of the ECB Council since the meeting last month Liebscher (member until end-August), August 29 "... the increased danger of second round effects, demand a responsible course of action by the social partners and the public administration, but also the special attention of the ECB council to keep inflation expectations in tune with the target of price stability." Weber, August 27 "Monetary policy at the moment is roughly where it should be and I think the discussion about declining rates in Europe is premature." "I wouldn't say we've seen massive broad-based second-round effects yet, but some already have emerged (and) we are still concerned that more broad-based second-round effects could emerge"... "If the economic outlook brightens somewhat again towards the end of the year and next year, which I still expect, we'll have to see if action is necessary" Smaghi, August 27 "If the central bank decided to stimulate the economy by lowering interest rates this would have the effect of increasing inflation. Are we sure that is what we want?" "... the decision (to hike rate in July) we believe is most correct to bring inflation back below 2% inside around a year and a half". Weber, August 14 "The German and the European economies remain in a robust state. Discussion about the end of the upturn is misplaced." "The confidence of some observers that slower growth will lead to ebbing inflation pressures is in my view premature". Weber, August 12 "We must prevent expectations forming in people's minds that the inflation rate could remain as high as it is now in the medium term, and thereby be used as the bar for wage negotiations." Liebscher (member until end-August), August 11 ""If you switch to growth rates of 1.6-1.8%, no one can really convince me that we are in stagnation" "There is absolutely no room for complacency. The outlook over the medium term is that on the one side we only see a protracted period of inflation rates higher than our price-stability goal, and on the other side the reduction (of inflation) will only occur in a rather moderate way." Danske Bank http://www.danskebank.com/danskeresearch Disclaimer This publication has been prepared by Danske Markets for information purposes only. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. 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