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European Update

Posted by Marge Maresca on Sep 5, 2013 1:00:00 PM


The ECB monetary policy decision was no change as expected. The refi rate remains at 0.5%, the rate on overnight deposits at 0.0%. ECB President Draghi’s statement and press conference a little while later were more interesting.

First, Mr. Draghi reiterated the ECB’s forward guidance, indicating that rates will be kept at “present or lower” levels for an “extended period of time.” This remains unspecified for now, but plainly monetary policy will not be tightened any time soon. The Governing Council was unanimous on maintaining current guidance.

Secondly, minor revisions to the ECB’s GDP growth and inflation forecasts were announced as expected. The changes were not significant and rather represented something of a “mark‑to‑market” exercise. GDP growth is now forecast to run at ‑0.4% YoY in 2013 (previously ‑0.6%YoY), followed by 1.0% YoY in 2014 (previously 1.1% YoY). The upward revision to 2013 forecasts was driven by the better than expected outturn for QII 2013.  The inflation forecast for 2013 was revised up a tenth to 1.5% YoY, that for 2014 was unchanged at 1.3% YoY. The ECB’s view of the economic outlook remains broadly unchanged, risks remain
skewed to the downside. Recovery “shoots are still very green.”

Thirdly, Mr. Draghi acknowledged that the ECB is closely monitoring money market conditions and the impact the withdrawal of LTRO cash is having on liquidity conditions. Current excess liquidity is “adequate” and the ECB stands “ready to act” on liquidity if needed. The “full allotment” policy will remain in play as long as needed.

Fourthly, and of most interest for markets, Mr. Draghi indicated that the ECB discussed a rate cut today. However, there was disagreement on the Governing Council. Some Governors said that the economy “does not justify a rate cut”, other that the recovery was “still green.” Mr. Draghi indicated that the economy “remains too weak to exclude discussion on rates” and added that the ECB “would consider a rate cut if market rates were unwarranted.” Mr. Draghi explicitly stated that he wanted to make clear that the ECB Governing Council has a “downward bias” on rates. Of course this is already explicit in the forward guidance. The revelation that a rate cut was discussed today suggests that the bar to further easing is not particularly high, although any such measure would need to be triggered by either a period of renewed economic underperformance relative to expectations or an unwanted further back‑up in market interest rates.

Fifthly, the ECB continues to work with the EIB and European Commission on plans to stimulate SME lending. Finally, Mr. Draghi announced that there will be positive news on the Single Supervisory Mechanism SSM in coming days. Discussions “progress considerably”, the first full communication on asset quality review will be in mid‑October some time.  The ECB is scheduled to take over responsibility for Eurozone banking supervision next year.

Unsurprisingly the main market reaction came in response to the comments that the ECB had discussed a rate cut today. But it is clear that European and ECB policy‑makers remain active on multiple fronts to help support the Eurozone economy on its recovery from recession and keep financial markets and the banking sector functioning smoothly and effectively.  More outright monetary stimulus remains a distinct possibility this year. Certainly there will be more policy measures announced in coming months.


Today’s BoE decision resulted in no change to monetary policy settings as had been widely expected. Bank rate remains at 0.5%, the asset purchase target at GBP375b. More interestingly, there was no attempt by the MPC to jawbone money market interest rates lower as had been expected by many commentators. This counted as something of a surprise given the BoE’s new forward guidance and Governor Carney’s supposed preference for aggressive communication.  It appears that the MPC are prepared to tolerate some of the tightening in monetary conditions triggered by rising market interest rates, GBP rallied a little accordingly. Of course, this may be simply a matter of degree. Any further back‑up in interest rates may still induce a response  from the BoE. But today at least the MPC saw no cause to comment further.

European Markets

There was not much to report through the European morning ahead of the 2 major central bank meetings. EUR/USD spent the morning ranging in the 1.3160-1.3200 area GBP/USD was likewise roughly flat around the 1.5600 area. Equity indices were also roughly flat, the big moves of the morning were in the bond markets.  Bund yields were 5bps higher by mid-morning and honing in on the 2.0% level for the first time since QI 2012. This mark was reached late in the morning session, another staging post in the post-crisis normalisation of markets reached.

The central banks then moved to centre stage. First up was the BoE. There was no change to
policy, but more importantly for markets no attempt to jaw-bone lower UK money market rates either. This was something of a surprise to many market participants, GBP/USD spiked up over 1.5660. A little while later the ECB left its monetary policy settings unchanged as expected, there was no market impact. A fractionally softer ADP print was also ignored by markets. Then ECB President Draghi moved to centre stage.

The EUR started easing lower through his press conference as first forward guidance was re-iterated and then Mr. Draghi indicated that the Governing Council had discussed a rate cut. EUR/USD dipped close to a big figure under 1.3150 before edging back up into the US ISM non-manufacturing print. This was much better than expected and the USD rallied across the board. EUR/USD dropped down to a low of 1.3111, USD/JPY pushed up to 100.17. Treasury and bund yields both had major up-days, 10-year yields rising 8 and 10bps respectively. Equity indices had another fairly lacklustre day through the excitement, the Eurotoxx closed0.6% up, the S&P 500 was 0.1% up by the European close. Non-farm payrolls looms ahead.


The ISM non-manufacturing survey posted a bumper 58.6 headline reading. This was a high since 2005 and confirms that the US recovery is progressing at a healthy clip through HII2013. The business activity sub- index rose to 62.2, orders to 60.5 and the employment sub-index to 57.0. The survey was across the board buoyant. US HII growth is shaping to run above trend.

ADP jobs grew by 176k in August, a 3-month low, but still decent. July gains were revised 2k lower to 198k. 


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