Watchful ECB likely to keep powder dry tomorrow
By Mads Koefoed
Bottom line: The euro area economy continues to show signs of improvement, but disinflation and declining bank lending will keep the European Central Bank on its toes. Nevertheless, I expect the governing council to keep its powder dry when it meets tomorrow and not lower any rates nor introduce other accomodative measures at the December meeting. President Mario Draghi though should be quite dovish.
Recovery underway: Signs of recovery continue to show up in incoming data from the euro area though the unevenness of recovery remains a concern as Germany, and to an extent Spain, show improvement while Italy and especially France seem stagnant. Overall, the picture of one of improvement, however, with the composite PMI rising to 51.9 in November (three-month average) from 51.4 in the third quarter and 47.8 in Q2. A reading of 51.9 in PMI is consistent with growth around 0.2 percent quarter-on-quarter.
Composite PMI is not the only improving indicator, however, with Eurocoin ("monthly GDP proxy") rising to 0.23 in November, according to available data. The indicator reached a cyclical bottom in August 2012 at minus 0.33 and has more or less climbed each and every month since, interrupted only be a two-month decline in May-June of this year. Unemployment too is showing tentative signs of having topped.
Lending, inflation remain weak: Inflation (at the consumer level) has trended down since the cyclical peak in June 2008 when it hit four percent, and now stands a just 0.9 percent, though that is a slight improvement on October's 0.7 percent. While I expect the disinflationary pressure this year and at the start of 2014 to be to some extent driven by temporary factors, an increase in inflation will be prolonged and subdued. Furthermore, lending to the private non-financial corporations continues to decline and is down 10.3 percent from the top in early 2009, and household lending is stagnant. Lagging indicator or not, the ECB pays attention.
Wrap: Following the 25 basis point cut in both the main refinancing and marginal lending rates in November, I look for no change in December. Economic data has mostly improved, but the weakness in the second (France) and third (Italy) largest economies will be a concern. Furthermore, the weakness in lending and low inflation will keep the ECB stressing that risks are to the downside. However, no unconventional measures will be adopted at this time through the ECB, but president Draghi is likely to stress that it has plenty of tools at its disposable, including long-term refinancing operations (LTRO) and quantitative easing (QE). BNP Paribas, as an example, now expects QE in mid-2014.
In addition, the staff economists will release their projection, including 2015, for the first time 2005 forecasts, which should show that inflation will move towards the target rate only very slowly. The September projections saw HICP inflation drop to 1.3 percent in 2014 from 1.5 percent this year and 2.5 percent in 2012. The GDP forecasts were minus 0.4 and 1 percent for 2013 and 2014, respectively.
— Edited by Martin O'Rourke