ONCE AGAIN, THE ECB MAY SURPRISE US
IN THE movie Groundhog Day, Bill Murray wakes up each day only to find himself repeating the activities of the day before. There is a bit of a Groundhog Day feel to the currency market this week, as traders once again prepare for the monthly European Central Bank (ECB) press conference. Recall that last month I noted that the euro would live or die by the pronouncements of ECB President Jean Claude Trichet – and indeed the unit tumbled nearly 900 points off its highs at the start of May, in the wake of Trichet’s dovish words.
This month, the market anticipates that the ECB will turn decidedly more hawkish and Trichet will finally signal a 25 basis point rate hike for July by using the code word vigilance. Although the Eurozone continues to be plagued by problems in the periphery, the ECB’s monetary policy is geared primarily towards the core economies of Germany and France. To that end, economic growth in Germany remains robust as unemployment declined to the lowest level since the re-unification, while retail sales led by strength in the core European economies saw their sharpest rise in thirteen months. Meanwhile, inflation shows no signs of easing, with PPI readings rising at a 6.7 per cent annual rate.
In short, there are many good reasons to believe that the ECB will pre-announce the tightening of monetary policy at this Thursday’s press conference (scheduled for 1.30pm London time). However, given the fragility of the situation in the periphery and the slowdown in the most recent PMI reports, the ECB may decide to err on the side of caution and hold off hiking rates until the autumn. Furthermore, a rate hike now would only exacerbate the overvaluation of euro-dollar, pushing it towards the $1.5000 level and making it more difficult for the export-driven German economy to maintain growth. If the ECB does surprise the market by remaining stationary, expect another sell off in euro-dollar. But, given the general weakness of the US economy, the correction this time around may not be nearly as steep.