Euro Immunity to Risk Trends May Fade as ECB Decision Approaches. Fundamental Forecast for Euro is Neutral. The euro is in an exceptionally interesting situation. Over the coming month, we are jumping from one major fundamental event to another week after week. And, these particular affairs are far more influential than just a mere economic indicator – they play to the very core of the currency’s fundamental appeal. Over the past few months, the euro has marked a notable departure from the financial concerns that plagued the region’s outlook on and off since the Greek bailout catalyzed fears that the monetary union itself was at risk. Yet, just in the past week, we have actually seen the neutral shift turn bullish with interest rate expectations leveraging the potential for capital and yield returns from this shared currency to a level that is well beyond many of its peers. The market will have enough fodder on hand to stir volatility and perhaps offer final adjustment to rate forecasts. The German unemployment change figures will steer the economic side of policy expectations. More pertinent though will be the Euro-Zone CPI estimate due Tuesday. Forecasts for an unchanged 2.4 percent annual clip of growth will keep the hawkish outlook in place without further accelerating rate watchers’ time frames. Alternatively, a meaningful deviation could pitch the euro into a meaningful drive.
Activity continued to expand in the last quarter of 2010. For the whole year, the average growth rate of GDP was 1.7%. According to survey data, the underlying positive momentum of GDP should be confirmed over the coming quarters. In February, the PMI surveys reached its highest level since July 2006. They were particularly strong in Germany and France. Better economic prospects and rising commodity prices have pushed up inflation. For the time being, inflation expectations are anchored and risks of second round effects on wages are low. The ECB is expected to deliver its first interest rate hike at the end of the year.
In Germany, in the fourth quarter, the increase in GDP (+0.4% q/q) was mainly again due to foreign trade. Moreover investment in machines and capital goods and public consumption bolstered economic activity. The business indicators herald sustained growth in the first part of 2011. GDP, which was up sharply from 2009 (+3.5%, after -4.7% in 2009), is likely to grow by close to 3% in 2011.
Looking at France, In BNP Paribas’ opinion, the noteworthy improvement in survey data at the turn of the year is all the more robust as it was recorded in several economies of the euro zone. Affected by the cold weather and strikes in the fourth quarter, economic activity is expected to accelerate slightly in the next few quarters. Overall, growth should come in close to 1.7% this year, up from 1.5% in 2010. Job creation, however, will remain muted as long as companies have not rebuilt at least partly their margins, which are still very low because of the crisis. The acceleration in commodity prices is fuelling the upturn in inflation and household consumption is set to slow down.
In Italy, Preliminary results for GDP growth in 2010 confirm the slower pace of economic recovery in Italy vis-à-vis Germany and France, with a still wide idle capacity preventing investment from a more vigorous rebound. Pressures from the cost of imported inputs are going to impinge on inflation and competitiveness.
The Spanish economy contracted by a slight 0.1% last year after falling by 3.7% in 2009. The main contribution to growth came from foreign trade. The gradual elimination of the imbalances built up over the past decade (property market bubble, private sector indebtedness) is likely to continue to depress domestic demand this year while the fiscal consolidation measures implemented in the euro zone is likely to dampen external demand. BNP Paribas expect GDP to contract slightly this year. This could mean that further austerity measures may be required to keep the fiscal consolidation programme on track. Lastly, the banking sector is undergoing major change and the savings banks segment, already concentrated, could move closer to the banks over the coming quarters.
In the eurozone, Ireland went to the polls Friday, although the outcome will not be known until sometime. The current government looks set to suffer a stinging defeat as a result of the huge cost to Irish taxpayers of the winding up of, not least, Anglo Irish Bank. Fine Gael, meanwhile, looks poised to be the runaway winner and the only real question is whether or not it will gain a clear majority. Our expectation is that it would have to form a coalition government – probably with the Labour party. The election is unlikely to result in any real shifts in policy. While the new government will attempt to renegotiate some elements of the EU/IMF deal and has not ruled out the banks’ senior bondholders carrying some of the losses, there are no plans for Ireland to go it alone.
The ECB’s Governing Council meeting on Thursday looks set to be unusually interesting. We will get to know if the ECB plans to continue with full allotments in its market operations. Danske expect it will shift to fixed allotments of large amounts at all auctions, enabling the fluctuations in surplus liquidity to be reduced. Banks in the GISP countries with liquidity problems can instead draw on their national central banks’ Emergency Lending Assistance. There will also be new ECB forecasts for growth and inflation. Keep a particular eye on inflation expectations for 2012. So long as they remain well under 2% the ECB will be in no hurry to raise interest rates. Listen carefully to the rhetoric too. The tone on inflation has hardened at recent meetings and one cannot rule out Trichet signalling rate hikes earlier than is generally expected. Consensus among ECB experts is an initial hike in Q4. This has long been Danske’s position, but the risk has shifted from it potentially coming later to an increasing likelihood of it arriving sooner.
The most important European data in the coming week will be inflation numbers, which will be under close scrutiny. Danske expect February’s eurozone inflation to have risen to 2.5% in February. Final PMI numbers are not particularly expected to surprise, while German unemployment is expected to remain at 7.4%. Finally, details of eurozone GDP growth in Q4 10 will be released on Thursday and Danske will in particular be looking for signs of private consumption beginning to pick up. Remember, though, that Q4 was weak, while Q1 this year looks set to be considerably stronger.