rating for Greece, negative outlook for other EMU countries
off to a disappointing start
Â·ECB view that
inflation risks are balanced is difficult to comprehend
Euro under pressure
the course of the week, EUR-USD has fallen significantly. The single European
from about 1.37 at the end of last week to below 1.31 at times and was trading below
1.33 at the close of the week. In our view, there are three major factors
weighing on the euro at present:
The drastic deterioration of the growth outlookin the eurozone:
It looks as though economic output will
contract even more sharply in the eurozone than in the US
in 2009. Against this background, markets are assuming that further sizeable
interest rate cuts will be necessary in the euro area. The reactions of
policymakers, including the ECB, are regarded as being too slow and inadequate.
And if policymakers do not pull out all stops, stabilisation will be delayed,
and the problems will intensify.
Weakness in equity markets:
from the weak economic data, the start of the reporting season is currently
dampening investorsâ€™ mood considerably. The earnings reports released so far
have not been at all encouraging.
Concern over the fiscal strength of some euro nations:
credit rating has been downgraded, the outlook on some other EMU member statesâ€™
ratings has been put on negative, and there are rumours (officially denied)
might request the support of the International Monetary Fund. There is growing
concern that some of the smaller member states, which are in a weaker economic
position, might not be able to withstand the fiscal burden of the financial and
economic crisis. There is considerable uncertainty in the markets about the
risks stemming from the financial and property sector; one chilling example is Iceland,
where the extent of the debt burden exceeded the countryâ€™s economic output by far.
Moreover, the institutional uncertainties are higher than in the US
for example: how much solidarity
is there amongst the member states, and will the ECB be the lender of last
sustained slide of the US economy â€“ where the rapid increase in unemployment is
threatening to put consumer spending under even more pressure â€“ is not having
an impact on the dollar at the moment. This is probably partly due to the Obama
factor. His inauguration stands for a fresh start, and the massive stimulus
package, currently in preparation, is making the political event more significant.
The $800bn package is likely to help to stabilise economic activity, at least
for a while. (In the long term, however, it should be borne in mind that the
correction of the US
current account deficit is an essential part of the global adjustment process.
Thus the dollar only has limited appreciation potential).
EMU inflation risks balanced?
ECB has succumbed to the pressure of the data and cut interest rates by 50
basis points to signalled that there was still scope for further cuts, but that
a decision was not likely to be taken until March, when the new macroeconomic
projections are released.
cutting interest rates on Thursday, the ECB acted as markets had been
expecting. Over the
few weeks, the economic indicators had deteriorated so drastically, that the
was no longer valid. However, the accompanying statement and ECB president Trichetâ€™s
comments betray a certain lack of direction. The ECB governing council did
admit that growth risks have become evident and that inflation pressure has
diminished â€“ due to the unfavourable growth outlook. And it said that there is
unmistakable evidence of downside risks to growth, despite the interest rate
cut. But at the same time the governing council kept claiming that the
medium-term inflation outlook corresponds with the price stability target (this
had already been maintained in December) and that the risks are broadly
balanced. This assessment of the risks to price stability is inconsistent: the
need for revision, which the ECB sees on the growth side, implies a continuous and
marked widening of the demand gap, presumably over the entire projection period
until the end of 2010. This means pressure on prices, especially if there is
increasing excess supply worldwide. Therefore the inflation forecast for 2010
would have to be reduced.
the more so, since the December inflation projection was based on much higher
oil prices i.e. $67 in 2009 and $77 in 2010 â€“ at an exchange rate of 1.27. Oil
market futures prices are currently about $15 lower for both years. All in all,
the ECBâ€™s December inflation projection with an average of 1.8%, is now just as
invalid as the growth projection. But apparently the ECB is still loath to
acknowledge downside risks to price stability, i.e. deflation risks, and to
take the monetary policy consequences.
Rieke +49 69 718-4114
Grabbe / Klaus NÃ¤fken
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