European Fundamental Outlook 01/13/13

The European Central Bank retained its policy stance

For Monday, anticipate the Euro to show some negativity in its currency valuation, as the ECB made its first policy meeting early this year and as expected it did retain its policy stance, which most analysts had expected that the ECB would remain in abeyance because of a recent signs that the recovery is underway which might spell optimism in the euro area countries, though is a slow pace. With a positive light shed by the rising of its Economic Conference index for 8 consecutive months in December, and now it stands in its highest level ever since mid-2011 when the Eurozone slid back into recession.

Furthermore, Retail Sales in the Eurozone is showing luster by rising 1.4% in November relative to the previous month. Not only was the outturn significantly stronger than the consensus forecast, but it was the largest monthly increase in four year. The 1.9% rise in the German Industrial Production in November adds to the evidence that the German factory sector is gaining strength again. However, the ECB remains biased to ease policy further. In its policy statement that was released after the meeting, the ECB Governing Council reaffirmed that it expects “key ECB interest rates remain at present or lower levels for an extended period of time.

Moreover, although a recovery seems to be underway in the Eurozone, it is by no means firmly established yet. Further, the ECB’s single policy objective is to maintain CPI inflation below, but close to 2%. With CPI inflation at both the headline and the core measures running below 1% at present the core rate if CPI inflation fell to an all-time low of 0.7% in December it is difficult to make the case that CPI inflation is close to 2%. Although, deflation has not set in the overall euro area, there are some countries where extremely depressed economic activity has eliminated any inflationary potential, at least in the foreseeable future. CPI inflation is more or less flat in Ireland, Portugal and Spain at present, and the consumer price index in Greece is actually 2.9% lower today than it was a year ago.

Corollary, the projections that the Eurozone’s GDP growth is correct, which means that the real GDP in the overall euro area will grow a bit more than 1% this year following a contraction on the order of 0.4% in 2013 then deflation in the overall euro area likely will not take hold. However, the forecast that CPI inflation will not return to 2% between now and the end of our projection period. Therefore, there is a significant possibility that the ECB will cut its policy rates further at some point in the next few months. Thus, the only extreme circumstances would lead the ECB to slash its deposit rate below its current setting of zero percent. However, the refi rate, the ECB’s main policy rate, currently stands at 0.25%. Although the ECB probably won’t cut the refi rate all the way to zero percent, since there is a strong case to be made for a cut to 0.10%, if this happens then the euro could encounter selling pressures.

Commentary

For the coming European session, anticipate further signs of optimism for the euro area, as the ECB made its first policy meeting early this year and as expected it did retain its policy stance, which most analysts had expected that the ECB would remain in abeyance because of a recent signs that the recovery is underway which might spell optimism in the euro area countries, though is a slow pace. With a positive light shed by the rising of its Economic Conference index for 8 consecutive months in December, and now it stands in its highest level ever since mid-2011 when the Eurozone slid back into recession.

In addition, Retail Sales in the Eurozone is showing luster by rising 1.4% in November relative to the previous month. Not only was the outturn significantly stronger than the consensus forecast, but it was the largest monthly increase in four year. The 1.9% rise in the German Industrial Production in November adds to the evidence that the German factory sector is gaining strength again. However, the ECB remains biased to ease policy further. In its policy statement that was released after the meeting, the ECB Governing Council reaffirmed that it expects “key ECB interest rates remain at present or lower levels for an extended period of time.