The two faces of the ECB

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The European Central Bank pushed ahead with its much-anticipated tightening yesterday, at the same suspending collateral rules for Portugal within its liquidity operations.  There’s a sense that it is running scared on the liquidity side, whilst at the same time acting tough on the monetary policy side, perhaps in compensation for the former.

What remains surprising is that the ECB is making a mistake that was made right at the beginning of the financial crisis.  Back then, central banks were keen to split the monetary policy and liquidity provision elements of their role.  The ECB was at the forefront of this, providing the market with unlimited liquidity provision in August 2007, but keeping rates unchanged (and eventually hiking them a year later, mistakenly) in the belief that the economic impact would be limited.  This is the correct approach, but only up to a point.  The point is when the impact strays from the financial side to the real economy, something which now seems unavoidable.

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Commentary

Payrolls may provide some reassurance on US recovery.  It is just possible that the US economy is emerging from the soft patch that it was enduring during most of last quarter. According to the ADP survey, private payrolls were up 157K last month, after a paltry 36K increase in the previous month. Because of the reduction in public sector workers going on right across the country, non-farm payrolls for June will probably be nearer the 100K mark for the month. Although an improvement, an increase of around 100K will probably not be enough to absorb new labour market entrants. As a result, the unemployment rate is unlikely to fall in the month from May’s 9.1%. Separately, US retailers such as Gap and Limited Brands are reporting that sales last month were remarkably decent, helped by aggressive discounts, warmer weather and lower gas prices. For the dollar, any signs that the economy is recovering some of its lost traction will probably be warmly received.

German trade numbers surge again.  The data for May, released this morning, showed the trade balance widening from EUR 10.8bn to EUR 14.8bn.  Exports surged once again, this time by 4.3%, with the trade balance having increased 9% so far this year compared to last year.  The main area of growth is exports to non-eurozone EU countries.  The data once again underlies the rewards that are coming from Germany’s competitive position.

Swiss franc gently returning to favour.  Last week was one of the worst for the Swiss currency for a couple of years, but that blip has been quickly forgotten with a rapid return of buying interest over recent days. This should hardly be a surprise given the ongoing sovereign debt crisis in Europe and the desire by savers in the likes of Greece, Portugal and Spain to protect their wealth by moving it to a safe harbour. EUR/CHF, which started the week above 1.23, traded below 1.20 yesterday, although it has since reversed to stand around 1.2120. Europe remains in a huge pickle over how to respond to the sovereign debt crisis, with the contagion spreading on a daily basis. Washington remains incapable of dealing with the country’s enormous fiscal deficit at a time when the debt limit is about to be reached and Japan’s finance minister has warned that the country might run out of money soon if the Parliament fails to authorise bond sales.  The SNB may wish that the currency would simply tread water for a time, although the Swissie’s buoyancy has helped to contain inflation, as confirmed once again by the latest figures released yesterday. Furthermore, labour market data this morning has shown the unemployment rate falling further to 2.8% in June.

The pound crawls into and beyond rate meeting.  Sterling failed to get excited by Thursday’s MPC rate meeting, cable barely registering the result. The production data for May, released earlier yesterday, showed a rebound on the headline production measure from the April weakness, which was impacted by holiday and the warmer weather.

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