Euroland: ECB Keeps Neutral Stance

Overview:

As expected, the ECB kept rates unchanged today and made only small changes to its statement. So although the ECB still sounds hawkish, the further recent rise in oil prices did not give rise to a strengthening of rhetoric. Inflation risks are still to the upside, but the ECB "believe that the current monetary policy stance will contribute to achieving our objective". The decision was unanimous and no one spoke in favour of rate changes in either direction.

Details:

Although minor, there were a few changes in the statement. The inflation assessment had a slight twist. Mr Trichet said that "inflation rates are expected to remain high for a rather protracted period of time, before gradually declining again". Previously he stated that it was a "rather protracted period of temporarily high annual rates of inflation" .This might indicate that the ECB now expects the period of high inflation to last a little longer than before - most likely due to the rise in oil prices as the ECB projections are based on forward oil prices. Also, Mr Trichet said that "in order to ensure that current high inflation rates remain temporary it is of imperative importance that the currently high inflation rates do not become entrenched in longerterm expectations or lead to broadly based second-round effects in wage and price-setting". Thereby, stressing that the temporary aspect of the currently high inflation rates is conditional on wage and price formation.

The growth assessment was broadly unchanged, with a slightly softer twist as it added this time that "economic sentiment generally continued to soften".

ECB indicated a slight rise in concern over credit availability. According to the ECB, availability of bank credit to euro area firms has not been significantly impaired by the financial turmoil thus far. However, speaking on investment growth this time, Mr Trichet omitted to mention that there are no significant signs of supply constraints on bank loans. Thereby, he may have given the first hint on signs of supply constraints to the corporate sector. Mr Trichet also commented on the ECB's lending survey in the Q&A session (released tomorrow at 10 CET) saying that it showed a further rise in credit tightening. And he added this time that credit growth was expected to moderate. This could signal that the lending survey tomorrow will not be too pretty.

Assessment and outlook:

The ECB is firmly on hold in the short term as it has to balance the upside risks to inflation against the downside risks to growth. With no big changes, the market reaction was very moderate. Going forward, we think triggers for an easing bias have to come from lower inflation and/or a further decline in the German ifo index and PMI indices. We think we will see this decline in surveys in the coming months. Our central case is therefore still a rate cut in September, but the continued rise in oil prices poses a significant risk to the forecast as it means inflation will stay elevated for longer.

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

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