Jul. 2, 2009 (Action Economics) --

ECB Snapshot

• The ECB left it refi rate unchanged at 1.00% in July, as expected.
  
• June HICP inflation dropped to -0.1% y/y from 0.0% y/y.
  
• German June ZEW confidence continued to jump higher, with current conditions also improving now.
  
• June manufacturing PMI improved while services PMI declined.
  
• June Ifo also improved again.
  
• June Economic Sentiment improved for a third consecutive month.
  
• May M3 money supply growth decelerated to 3.7% y/y from 4.9% y/y.
  
• Eurozone Q1 GDP contracted 2.5% q/q. Data point to at least another quarter of decline.
  
• Q2 survey of professional forecasters showed inflation expectations for 2009 were revised down to just 0.5% from 0.9%. The forecast for next year was cut to 1.3% from 1.6%, and the longer term outlook was left unchanged at 1.9%.
  
• Forecasters cut their 2009 growth projection to -3.4% from -1.7%, while the 2010 forecast has been revised down to 0.2% from 0.6% previously. The longer term projection was cut to 1.9%.
  
• June ECB revised staff projections see CPI around 0.3% in 2009, (previously 0.4%), and 1.0% (previously same) in 2010.
  
• June ECB growth projections see GDP down around 4.6% (previously -2.7%) in 2009 and at around -0.3% (previously 0.0%) in 2010.
  
  Outlook/Assessment: The ECB kept the refi rate steady at 1.00% as growth starts to stabilise. Officials have been warning against overdone growth optimism, but in the central scenario of gradually stabilising growth we see rates steady into 2010. Officials are starting to stress the need for an apporpriate exit strategy once the economy starts to turn around and the first rate hike could come earlier than some expect. (Last Update: July 2)

ECB Meeting Review

June Meeting

Trichet said in the introductory statement that "current rates are appropriate taking into account" the ECB decisions of early May, "including the enhanced credit support measures, and all the information and analysis which have become available since then." The central bank said it confirmed its expectation that price developments over the policy-relevant horizon will remain dampened by the marked weakening of economic activity in the euro area and globally." At the same time after two quarters of very negative growth "economic activity over the remainder of the year is expected to decline at much less negative rates" and positive growth rates are expected by mid next year.

This assessment already incorporates adverse lagged effects, such as the expected deterioration in labor markets. AT the same time inflation expectations remain "firmly anchored" and all in all the ECB expects "price stability to be maintained over the medium term, thereby supporting the purchasing power of euro area households". This introductory statement is clearly more optimistic on the growth outlook than previously and the fact that the central bank judges rates to be appropriate backs our view that the refi rate has troughed at 1.00%.

The latest ECB staff projections see GDP growth this year at -5.1% to -4.1%, that is around a mid point of -4.6%, while growth next year is seen between -1.0% and 0.4%. Both projections are lower than the previous staff forecasts, but the ECB already suggested at the last meeting that growth forecasts will be revised down, which indicates that the last cut already took account of the weakened outlook.

The ECB still judges risks to the outlook for economic activity to be balanced. On the one hand, there are concerns that the turmoil in financial markets could have a stronger impact on the real economy, as well as that protectionist pressures could intensify and that there could be adverse developments in the world economy stemming from a disorderly correction of global imbalances. The ECB now also sees risks from "more unfavorable developments in labor market".

On the other hand, "there may be stronger than anticipated effects stemming from the extensive macroeconomic stimulus under way and from other policy measures". There may also be a quicker improvement in confidence than currently expected. This again sounds more optimistic than last month, which is no surprise after the wave of positive survey findings since the last meeting.

Turning to inflation, Trichet noted the decline in the headline rate to just 0.0% y/y in May but repeated that "the further decline in inflation rates was fully anticipated and primarily reflects base effects resulting from the sharp swings in global commodities prices over the past 12 months".

Trichet said again that, due to base effects, annual inflation is likely to decline further, and remain negative over coming month before rising again later in the year. Trichet repeated "such short-term dynamics are, however, not relevant from a monetary policy perspective". The new staff projections see inflation around 0.3% this year and 1.0% next, which is little changed from the March projections. Trichet stressed that medium term inflation expectations "remain firmly anchored in line with the Governing Council's aim of keeping inflation rates at levels below, but close to 2% over the medium term".

As last month, the ECB judges the risks to the inflation outlook to be broadly balanced, and Trichet repeated that they "relate in particular to the outlook for economic activity", while on the upside they relate to higher than expected commodity prices. The ECB now also warned that "increases in indirect taxation and administered prices may be stronger than currently expected owing to the need for fiscal consolidation in the coming years".

Turning to monetary developments, the ECB noted the marked decline in M3 growth and the pace of underlying monetary expansion, as well as private sector credit growth. However, the central bank continues to suggest that the deceleration in lending to noon-financial corporations partly reflects "a lower need for working capital" and is demand driven. The statement reads that "the past reductions in key ECB rates have continued to be passed on to lending rates to both non-financial corporations and households", adding that "the resulting improvement in financing conditions should provide ongoing support for economic activity in the period ahead."

All in all, the ECB summarized that "the current key ECB interest rates are appropriate taking into account our decisions of early May, including the enhanced credit support measures, and all the information and analysis which have become available since then". Growth is expected stabilize stabilise and improve gradually, while inflation expectations remain firmly anchored in line with price stability,while the cross check with the monetary analysis supports the assessment of moderate inflationary pressure. Against this background the ECB expects "price stability to be maintained over the medium term".

Trichet stressed that monetary policy works with time lags and will therefore take time to feed through. Once the economic environment improves, "the Governing Council will ensure that the measures taken can be quickly unwound and the liquidity provided absorbed".

Bottom Line/Assessment: The ECB is clearly getting more optimistic on the growth outlook and the comments that rates are appropriate suggest that the refi rate has troughed. Indeed the central bank is already starting to look to appropriate exit strategies once growth has stabilized.