Looking Forward at the ECB?
Without much ado the ECB chose to lift its main refi rate (Q&A here) yesterday to 4%, a move which of course was widely expected. The interesting thing from hereon is of course what to expect in the remainder of 2007 from Frankfurt? Clearly the inflation bug seems to be going around at the moment all and not just in the Eurozone but how long can the ECB stay vigilant and will economic data prompt it to hold prematurely? There are consequently a lot of 'what-ifs' flying arond at the moment which I also highlighted in a note a few days back. Regarding the rate forecasts it seems as if only an abrupt and wide slowdown will prevent the ECB from moving to 4.25% come September. EuroIntelligence nudged up their forecast to 4.25% and over at Morgan Stanley the analyst team even opens the door for the hiking to proceed as far as to 4.75%. This however remains a 'risk scenario' according the MS team and what is important I think is that most analysts now agree that the ECB is moving close to restrictive territory (save of course Weber :)) which means that the ECB is set to become more data dependant. Yet, Morgan Stanley does see considerable upside risk in terms of inflation and with their growth revision of Q2 GDP to 0.7% the message from MS is clear, inflation and growth still has some way to up and thus also rates. Especially, wage push inflation is noted due to capacity constraints. Especially the point about capacity constraints is interesting and demands much attention in my opinion since we need to ask ourselves why in fact capacity constraints might be prevalent in some regions and countries.
Regarding real economic data there is a bit of both positive and negative for the high lords of ECB to depart on weekend with. On the positive front Q1 GDP figures were revised upwards in Italy on upbeat consumer spending figures and compared to Q4 06 growth was more balanced ...
Exports contributed 0.4 percentage point to growth, the same as consumer spending. In the previous quarter exports contributed 0.7 percentage point, while household spending added 0.1.
Meanwhile in Germany, industrial production slipped in April mainly due to a slump in construction. The decline was a hefty 2.3% and according to analysts the figure is biased to the downside due to the extremely buyoant performance of capex in Q1. Coupled with the fact that order books remain full we should perhaps expect some upside in May? I am not sure, we have seen, on a general basis, lately that manufacturing in the Eurozone has shown some signs of waning off admittedly from a very high level of growth. Exports from Germany also showed signs of a slowdown in April although a 13.1% increase y-o-y in April hardly constitutes a 'worrying' sign I would say. Having said that, a narrowing trade surplus on the back of a slowdown in the US would feed back rather directly into German growth rates since as we know capex is for a large part determined by export performance. Furthermore, with the US trade deficit narrowed on the aggregate in April despite widening with China it could seem as if the weak Dollar is finally paying off. So ok then, de-coupling is perhaps occuring at the moment but the question of course is for how long this can remain the salient trend and whether de-coupling at this point is structural of cyclical?
No need to stay persistingly against the consensus when you know you are wrong. As such my claim that the ECB would hold at 4% seems to be pretty much off base. I still expect real economic data to fall short off the bulls' expectations but not nearly enough for the ECB to consider holding at 4% although especially domestic demand figures will crucial here I think. Consequently, 4.25% seems a safe bet and futures markets indicate that a move towards 4.5% is not far fetched either. At the end of the day the ECB will also be watching inflation very closely and if the headline continues to tick upwards and if wage pressures and producer prices indeed push through to core prices then the ECB is likely to move I think. As for general growth rates in 2007 we are most likely going to see impressive growth rates mirroring 2006 albeit perhaps not as strong. I am closer to an annual growth rate of 2% than one of 2.5% which is rather on the pessimistic side relative to the official forecast from the ECB which rests between 2.3% and 2.9%.