4.00% or 4.25%? ... The Plot Thickens in the Eurozone

This is just a small update relative to my previous note on the Q2 GDP data from the Eurozone. And why do we need an update then? Well I am changing my interest forecast that is why.  

In essence, it is funny how quickly things can change in economics is it not? With the surprising acceleration of the Eurozone in Q4 2006 most pundits and commentators were sure that the Eurozone was in for yet another stellar year. However, with the recent GDP slowdown recorded in Q1 and Q2 2007 it seems as if the current growth forecasts will need to revised downwards significantly to reflect the economic fundamentals. In this way we can ask whether in fact the Eurozone will be able to clip in 2% of GDP growth in 2007 on an annualised q-o-q basis? This might seem a ridiculous claim at first but it is well substantiated if we look for example at Italian GDP growth which is set to stay below 1% on a quarterly annualised basis; if you don't believe me Edward Hugh has the relevant analysis. Moreover, if we turn to the Eurozone's biggest economy Germany we can also see that the outlook is not exactly looking positive as we move forward. Add to this, the latest readings on consumer confidence which also dipped in August and the picture is becoming increasingly clearer; see the original GFK announcement in PDF.

Of course, this recent deterioration of economic fundamentals has the US subprime mortgage crisis and subsequent potential liquidity/credit crunch written all over it. However, we need to think about that before all this mess began to trickle down into the markets we already had extensive downward pressure on the Eurozone economy in the form of fiscal tightening, a very vigilant ECB and of course a slowing US economy on the back of a slump in the housing market. At this point it is of course difficult to exclude the financial market wobbles entirely but as I have argued extensively here on this blog the growth forecasts and general sentiment regarding the Eurozone had been somewhat off base regarding economic fundamentals. In this way, the Eurozone's growth performance as it is set to bear out at this point is not surprising seen from my desk. Another thing we need to consider here is the viability of the so-called de-coupling thesis and whether in fact this is what we are seeing? It does not exactly look as such now does it? 

Turning to the more pertinent question of whether the ECB will take it to 4.25% as it was more or less promised a month ago the plot has indeed thickened lately. As I hinted above I am nudging my forecast down to 4.00% (alongside Eurointelligence) which means that I think the next meeting scheduled in the beginning of September will see the ECB hold. My main impetus is the recent remarks made by Trichet in a speech on Monday in which he toned down the ECB's pre-commitment to raising come the next meeting on the back of the recent turmoil in financial markets. The nature of the whole situation clearly makes any rate call pretty uncertain at this point since the ECB has now indicated that the decision would be stop and go relative to the unfolding events in financial markets and the perceived need to shield European banks. In this perspective and as always there is a considerable difference between what you think will happen and what you think should happen. Regarding the latter I have argued extensively throughout H1 2007 that the ECB was playing with fire by raising so aggressively. My argument was mainly based on the fact that the ECB was trading too aggressively on the dilemma between real economic fundamentals relative to perceived inflation pressures from monetary aggregates and wage deals. At the current juncture it is of thus also almost ironical that the turmoil in financial markets is winding up just at the time where it would indeed seem prudent for other reasons for the ECB to come off its hiking course. In this way, it is difficult to see how much of the recent dim news coming out of the Eurozone can really be directly related to the mess in financial markets (although of course this is main discourse at the moment) but one thing is certain. It is not going to be make the outlook any more positive in an environment where it seems that an economic slowdown is coming regardless of what happens in financial markets.