FX Research - FX Briefing - ECB meeting eagerly awaited
FX Briefing 29
expectations indicate recession
rate heralds downward trend in August
Â·ECB likely to
place more emphasis on growth risks
ECB meeting eagerly awaited
moved somewhat erratically this week. On Tuesday, the euro slipped to a weekly low
of 1.457 against the dollar, as weak business climate data from Germany
triggered speculation about interest rate cuts. Later in the week, however, markets
were taken aback by remarks from ECB representatives such as Axel Weber and Lucas
Papademos, who said that talk of interest rate cuts was premature and that, due
to the high inflation rates, the central bank might even need to consider
further rate rises. This pushed the European single currency over 1.48 for a
time. Crude oil prices rose in connection with hurricane Gustav, which probably
weakened the dollar too. However, at the end of the week, at 1.472, EUR-USD is
about 1 cent below last Fridayâ€™s level again, not least due to favourable EMU
results of the August ifo business climate were much worse than expected;
business expectations, which had already fallen sharply the previousmonth, fell
again more sharply than the assessment of the current situation. The
deterioration in the manufacturing sector was particularly marked. There was
also a further drop in sentiment in the retail trade, despite hopes that it might
have stabilized somewhat due to having plummeted the previous month. All in
all, expectations have plunged to their lowest level since February 1993. Thus
the assessment of the current situation, which is still relatively high, could well
drop significantly in the coming months; the business climate will therefore
deteriorate further. The downward trend in the EMU economic sentiment, which
had started in June 2007, also continued; it has now reached its lowest level since
March 2003. The current data give no indication that the economic downturn is
limited to the summer months and that growth will stabilize again towards the
end of the year. This is what Axel Weberâ€™s hawkish remarks were based on. The
OECD composite leading indicators published at the beginning of August show the
recessionary tendency prevailing in all major economies with the exception of China
Moreover, there is little hope of consumption driving growth in the eurozone
either; the detailed breakdown of the German GDP data published at the
beginning of the week showed that private consumption fell in the last three
quarters, despite a more favourable labour market and higher wage increases.
Thus consumption has been in recession for some time.
Weber is correct in his assumption that, despite weak global growth, harmonized
inflation in the eurozone will still on average remain above the ECBâ€™s target
of around 2% in 2009. But the fact that inflation rates have now peaked will
have a significant impact on inflation expectations. In Germany,
harmonized consumer prices dropped by 0.4% month-onmonth in August, and this
was not just because of the energy price correction. The development of prices
has been more favourable than expected in the eurozone too; the flash estimate
for August showed that inflation fell from 4.0% to 3.8% year-on-year. As the
decline in annual inflation rates will accelerate until the end of the year,
its meeting next week, the ECB governing council will probably emphasize the
inflation risks again as at the beginning of August. Nevertheless, its risk
assessment is likely to be more balanced. Given the weak economic signals, Jean-Claude
Trichet will, unlike Axel Weber, avoid talking about the possible necessity of
interest rate hikes. As far as the projections are concerned, we are expecting
the most significant changes to be on the growth side: the central projection
for 2008 GDP growth is likely to be revised down from 1.8% (as forecast in
June) to 1.5%, and for 2009 from 1.5% to 1.2% or even 1.1%. On the other hand,
the inflation projections for both years might only be raised by 0.1 percentage
points to 3.5% and 2.5% respectively.
Bank of Englandâ€™s monetary policy committee meeting is also taking place next
Thursday. At the last meeting, seven of the nine committee members voted in
favour of keeping interest rates on hold, one member voted to raise them, and another
to cut them. Due to the sharp economic slowdown, the Bank of England is
expecting inflation to fall below the 2% target during the course of the 2-year
forecast period. But fears that inflation rates could go on increasing
initially could prevent an immediate interest rate step. Given the steep
deterioration in UK
economic data, however, we assume that the number of monetary policy committee
members in favour of taking such a step will increase.
as we are expecting, the ECB Council expresses mounting concern about the
this is likely to be the most important signal for the forex markets next week.
then be scope for the euro to fall again, even if important US
economic data due next week turn out weak for the most part: we are expecting
both ISM indices to have contracted again in August, and non-farm payrolls to
have fallen more sharply. This would make it clear that the acceleration in
annualized growth in the second quarter to a revised 3.3% qoq was only a temporary
phenomenon. The tenor of the Beige Book on economic growth and domestic demand in
particular is likely to be similar.
Meister +49 69 718-2600
Grabbe / Klaus NÃ¤fken
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