Will the ECB do the right thing? (Video)

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If yesterday’s ‘steer’ from Bloomberg on the ECB meeting today proves to be true, then the ECB is going to fall into line with our expectations, as outlined yesterday (and below) and also last week (The ECB finally gets it).  This will involve a 25bp cut in rates, more measures on liquidity, but not real change in its bond-buying program.

Quite rightly, the ECB does not want to commit to anything more drastic before the EU summit has agreed on some significant measures on the fiscal front to create a roadmap towards greater fiscal integration. The single currency initially softened through yesterday afternoon on this story but has since recovered a touch to push back above the 1.34 level in early European trading. The ECB’s modest caution towards the promises of politicians should be welcomed. Daily brief, in the video below:

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Commentary

The scope for ECB disappointment.  There are several dimensions to ECB policy now (rates, liquidity, bond purchases) so it’s difficult to split the difference in terms of the shift in expectations around all three. The fact is that EONIA forwards have so far this week edged back a little on the amount of easing priced in for today’s meeting.  At the middle of last week, the market was just about fully priced for a 25bp easing of policy today.  The market is now placing around an 80% probability of that outcome.  It’s likely that this tempering of rate expectations is based partly on the belief that the ECB may be, or may indicate its intention to be, more aggressive with respect to bond purchases in the coming weeks.  This was what the market interpreted as the implications of Mario Draghi’s comments in front of the European Parliament last week.  We expect the 25bp easing will be delivered.  This would merely unwind the two rate increases seen in April and July, both of which we disagreed with at the time.  As such, it’s not surprising that we think more rate cuts will be seen in the early part of next year.  The main issue for today will be the weight of expectation placed on Draghi to commit to further and more aggressive bond purchases. On this issue, the market could well be disappointed, as suggested by the Bloomberg story of Wednesday afternoon.  Unfortunately, the BRICtiming is not great, with the ECB meeting coming ahead of the EU summit. As such, a firmer commitment from the ECB could well be premature.  The ECB has been caught out before relying on hollow promises (such as from Italy back in August).  It’s doubtful that it will make the same mistake again.

BRICing it. The release of GDP data from Brazil this week undermined, at least in the short-term, the presumption that the emerging nations could continue to pull ahead of the G7 given current conditions. Quarterly growth was flat, the lowest outcome for nearly three years.  Much of this weakness was down to government spending and industrial output.  The weakness is not wholly unexpected, the government having undertaken austerity measures and with the central bank easing rates from 13.00% down to 11.00% partly in response to this.  Whilst official data may not be as timely, there are concerns that China is also seeing a softening of output, based on the most recent PMI data.  The PBOC is already responding to this, having cut reserve ratios at the end of last month.   It’s not that surprising that we are seeing such outcomes from the larger emerging nations.  They are still tied to developments in those countries that are feeling the pinch from the credit crisis. But the longer-term prospects remain strong, beyond any short-term fluctuations in output.  Whilst sovereign debt ratios are set to rise over the next five years, the IMF sees overall emerging market debt falling from 39% of GDP to 30%.  For the G7, public sector debt is forecast to rise from 113% to 127% of GDP. Of course, there is margin for error in the numbers, but far less so in the divergence and direction between the major emerging and developed blocks. Ultimately, this should set emerging markets up for another period of de-coupling from western woes, beyond the short-term stress we may currently be seeing.

China applies brakes to yuan strength.  Against the backdrop of a significant slowing in the pace of recovery pretty much all over the planet, it is little wonder that Chinese policy-makers have been actively hosing down expectations for any further currency strength. This week, the Commerce Ministry remarked that there would be ‘severe’ pressure on exports next year because of reduced overseas demand and an increase in domestic costs. Premier Wen Jiabao has been a keen advocate of higher wages, including an improved social safety net, which has contributed to rapid growth in labour compensation. In November, the yuan actually declined against the dollar, a development that will no doubt stir renewed debate in Washington. China is clearly attempting to protect its exporters, understanding that slower global growth represents a significant risk for a sector that is the engine of their booming economy. Growth in exports has slowed rapidly over recent months, and the expectation is that they slowed further in November. The size of the trade surplus is also narrowing; after peaking at nearly USD 300bn in 2008 it has been declining and could come in at around USD 170bn this year. Contributing to the yuan’s recent softness has been an appreciable slowing in capital inflow.   For China, the economics of the situation suggest that yuan appreciation at this stage is not ideal. However, the political dimension is rather different, especially with the American economy still very fragile and the Presidential campaign soon to be in full swing. Once again, the yuan is likely to be a political hot-potato in America’s election year.

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