Available economic and financial market data since the last ECB governing council meeting do not suggest any change in the schedule for the clearly telegraphed June rate hike. While some council members started to flirt publicly with rates above 4%, suggesting that a further rate hike after June is possible, there were no statements indicating that the ECB is going to advance the rate hike to May.
Jürgen Michels Citigroup Director Economic & Market Analysis expects the wording in the pre-rate decision board meeting press statement to be escalated to “strong vigilance†to ensure price stability.
Real economic data reported since the last ECB meeting were mixed. The new information is not likely to alter the ECB’s view a month before the June update of the ECB’s staff projections. Retail sales and industrial production for the first two months of 2007 suggest GDP growth moderated to about 0.6% Q/Q in 1Q 2007 from 0.9% Q/Q in 4Q. The latest business and consumer surveys remained at high levels, but were a little below consensus expectations.
The April survey results also highlighted that export-intensive manufacturing sectors remain the main driving force of the expansion. Indeed, the second consecutive small decline in the manufacturing PMI outside Germany in April suggests that a moderation in manufacturing activity in these countries might be under way, noted Michels of Citigroup.
In addition, recent housing market news suggest that the positive contribution from construction to GDP growth for the euro area excluding Germany is likely to shrink, although construction in Germany is likely to rebound after an expected drop in 2Q.
Most new data regarding the actual and near-term inflation outlook were benign. The flash estimate for the April harmonized inflation rate of 1.8% Y/Y (down from 1.9% in March) was lower than expected and producer price inflation continued to moderate in March.
Furthermore, Citigroup notes that consumer and business inflation expectations continued to decline in April, despite the increase in oil prices in recent months. However, industry inflation expectations remained at a high level.
The news from the recent money and credit data were mixed. Bad news were the unexpected jump in M3 growth from 10.0% in February to 10.9% in March and the unchanged high growth rate (10.8% Y/Y) of private sector credit growth. The ECB will probably highlight these as a major source of concern regarding future price stability. But, the momentum in bank loans has continued to moderate. Lending to households slowed from 9.8% Y/Y last April to 8.1% Y/Y in February to 7.9% in March, while lending to non-financial corporations slowed from 13.2%Y/Y in January to 12.6% Y/Y in February and 12.4% in March (see Figure 3).
Compared to the last ECB rate setting meeting, there was little news on wages. The widely focused-on wage talks in the German metal industry continue on May 3. As the ECB was not largely concerned about the above 4% annual wage gain (including a 0.7% one-off payment) in the German chemical industry in April, a likely total annual wage gain around 4½% in the metal industry should not be a huge surprise for the ECB. For the time being, there are few signs that weaker performing German sectors will show similar wage gains.
Thus, unit labor costs are likely to decline further in Germany in 2007 and will probably increase modestly in the euro area, notes Citigroup.
Since the April meeting, the EUR exchange rate, cited by several council members as an important factor for the ECB, continued to appreciate moderately by 0.9% against the USD and 0.5% on a trade weighted basis. As we have argued before, given the divergence between the export-led growth in Germany and the domestic -led moderation elsewhere in the euro area, the ECB might welcome a further tightening in monetary conditions via a stronger currency rather than further rate hikes.2 It is worth mentioning that the Eurogroup agreed to delegate the comments regarding the currency to their chairman Jean-Claude Juncker. As Juncker is currently not concerned about the EUR strength, there seems to be little near-term political pressure on the ECB to enact policies leading to a weaker EUR.
On balance, the new information since the April 12 ECB meeting does not suggest that the ECB has to advance the widely expected 25 basis point hike in June to the May meeting, which takes place in Dublin. Indeed, apart from the headline money and credit data, the latest information suggests that medium term inflationary pressures diminished somewhat, suggesting that there seems to be no need for a surprising rate hike in May, notes Michels of Citigroup.
At some point, the ECB might want to change from the recent tactic of “guidance by codewordâ€. Nevertheless, we do not expect a change at present, said the Citigroup research note dated May 4, 2007. The latest ECB Monthly Bulletin argues that the current system is working well: “Effective communication contributes considerably to the effectiveness, credibility and predictability of monetary policy…through the flexible use of implicit forward language in its regular economic and monetary assessment, the ECB has managed to give implicit guidance on its inclinations over very short horizons.†3 Given that, we do not expect them to change this communication tactic right now. Thus Citigroup expect the ECB to move to the next stage in announcing a rate hike in June with the “strong vigilance†phrase. But, in line with previous policies “avoiding any kind of pre-commitment with regard to future policy decisionsâ€, the ECB is unlikely to give much guidance about the policy rate policy after June.
Â
