ECB resists rate cut mood
Only one to go? After the Bank of England’s careful quarter-point cut in early February, a move which followed similar actions from the central banks of the US, Canada, Australia, Denmark and even Japan, the spotlight turned, by default, on the European Central Bank (ECB). But no such rate-cutting announcement followed the ECB’s latest meeting. Many investors, however, think that there are far fewer reasons for monetary policy to be eased in Euroland and there is a degree of sympathy for the men at the ECB given the murky outlook.
Merrill Lynch points out that the ECB has some difficult issues preventing rate easing, including above- target inflation and lower real interest rates and a booming labour market, with employment growth rates topping 3% in France, for example. Merrill Lynch goes on to argue that recent weaker data on the German labour market should not be seen as positive proof of an underlying weakness in the economy but is partly explained by poor weather. It also points to anecdotal evidence suggesting that the Germans enjoyed their Christmas shopping this year, normally a sign that consumers’ confidence and wallets are in good shape.
Martin Hueppi, global fixed income manager at Swiss group Clariden, explains, “We believe that the ECB is on hold and that there is no need for them to ease immediately. There needs to be more evidence of a slowing economy in Europe. Some of the smaller economies are not particularly strong right now, but the big economies – Germany and France – are still robust and it is these ones that really matter, in terms of economic policy for the whole of Europe.”
While the monetary decisions for the other central banks appeared to be much more obvious, the disparities in economic health across Europe do mean that the ECB’s position is certainly not an envious one. “Fresh inflation numbers out of Spain will highlight the ECB’s ‘inflation risk’ story,” argue the analysts at HypoVereinsbank, adding, “and then at the other end of the spectrum, a small increase in Italian GDP in the fourth quarter underpins the slowdown story in the Euro-zone.”
For some investors, however, the ECB’s decision to leave rates and monetary policy unchanged was a mistake. “The ECB sounds surprisingly upbeat about the growth outlook for the Euro-zone,” says Robeco’s Peter Eerdmans. “We disagree with the rosy prospects that the ECB is picturing for the Euro-zone economy. We do not share the view that the economy will be unaffected [by the slowdown in the US_economy] because of the closed nature of the Euro-zone economy. The scenario underlying our outlook and forecasts is of a synchronised worldwide slowdown, and we do not believe that this is fully discounted in the markets right now.” In the bulletin issued after its recent meeting, the ECB itself pointed to the conflicting signals: “a slowdown in M3 growth suggesting that risks to price stability are now more balanced”; but on the other side wages remain a concern and, the statement read, “the increase in some labour costs indicators in 2000 warrants close scrutiny”.
Robeco is bullish on bonds globally, arguing that economic conditions in the US have clearly worsened more rapidly than expected. Eerdmans adds a note of caution, however, “The consensus factor with respect to the US slowdown scenario makes us cautious about the prospects for the US bond market. Indeed, recent investor surveys – pointing to large-scale overweight positions in the US Treasury market – support this view.”
Eerdmans believes that Euro-zone markets offer better value because they have priced in less easing than Robeco believes will occur. The US yield curve has priced in cuts of about 50–75 basis points by the end of the third quarter of this year, and Clariden’s Hueppi agrees with Robeco’s assessment that this is about right. He does not, however agree with the notion that the European financial markets will be treated to a surprise early easing from the ECB, and does not believe that Europe will be dragged down into a recession by the US. “Maybe in the course of this year the bigger economies of France and Germany will indeed be showing a different picture and may well slow down, which would cause the ECB to act, but until they do slow_down the ECB should not need to be cutting rates.”