ECB - A Fairly Neutral Statement

Overview: The ECB held leading interest rates unchanged and made a fairly neutral statement at today's press conference. That said Mr Trichet did make a few remarks which were less hawkish than expected by markets. The market response was a moderate decline in yields. The new ECB projections did hold a downward revision of the growth forecast and upward adjustment of the inflation forecast. Our expectation is for ECB to be on hold on a 12 month horizon. We believe the market will price in further cuts as activity and unemployment deteriorate during the autumn. This points to a further decline in bond yields.

Details: ECB presented the new Staff projections. Broadly in line with our expectations, the mid point estimates for year-on-year growth were revised from 1.8% to 1.4% this year and from 1.5% to 1.2% in 2009. The inflation forecast was lifted by 0.1%-point in 2008 to 3.6% y/y and by 0.2%-point in 2009 to 2.6%.

Overall we view the statement as fairly neutral. The tone in the growth section was almost unchanged. Compared to the previous statement they added that uncertainty surrounding the outlook for activity is "particularly high at the current juncture" and reiterated that "downside risks prevail".

A few comments regarding the risk to the outlook for price stability did have a slightly softer tone. The sentence "risks (to inflation) .. remain clearly on the upside and have increased over the past few months" was replaced by "there are upside risks to the outlook for price developments". It is also worth noticing that Trichet downplayed the upward adjustments of inflation projections a bit by saying that it was important to recall that these estimates "are based on a number of assumptions that are of a purely technical nature". This however is balanced by a sharpening of the remarks concerning the development in unit labour costs. The ECB now see "sharp increases" in unit labour costs as "wage growth has been picking up (whereas) labour productivity growth has decelerated".

The monetary pillar was also broadly the same as ECB continues to conclude that the "monetary analysis confirms the prevailing upside risks to price stability at medium to longer-term horizons". A few remarks on the monetary pillar were slightly softer than previously. This is mainly due to a more thorough review of the monetary analysis. Trichet mentioned that the current headline rate of M3 growth overstates the underlying pace of monetary expansion (as a result of the current flat yield curve). Furthermore, in the previous statement "monetary aggregates (did) continue to grow vigorously, with so far no signs of significant constraints on bank loan supply". In the current statement this is changed to "The growth of broad money and credit aggregates is now showing some signs of moderation".

Assessment and outlook: Overall the statement was fairly neutral. Thus we think the ECB is at a completely neutral stance. We continue to believe ECB will stay on hold on a 12 months horizon, but market expectations of a cut next year may increase as more weak economic data becomes evident during autumn. This points to a further decline in bond yields.

Danske Bank
http://www.danskebank.com/danskeresearch

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