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Can’t Always Get What You Want

ECB underwhelms, as the central bank remains reluctant to expand its balance sheet further. China: waiting for the stimulus to filter through.

Can’t Always Get What You Want
ECB underwhelms
After last week‟s Euro summit all eyes were on the ECB to see whether or not Draghi would “reward” the progress made there by loosening monetary policy further. In the end, the ECB did deliver to some extent as it cut the target refi rate by 25 bp while the deposit rate was even cut to 0%. The latter now makes the euro more attractive as a funding currency in FX space relative to other G4 currencies which was immediately visible in a depreciation of the euro.

The interest rate cut was motivated by fact that some of the downside growth risks were now materialising (which is partly an acknowledgement of the fact that Germany is now also decelerating). Since we believe that external demand is the only factor that can give the Euro area some traction again and because global growth continues to decelerate, we now believe that a further 25 bp cut will be forthcoming.

The cut in the deposit rate implies that the immediate action was a little bit more than expected. Yet, the ECB still managed to disappoint the markets because it was made very clear that the central bank remains reluctant to engage in another LTRO or give the ESM access to its balance sheet. Draghi stated that the LTRO‟s are too blunt as an instrument because they do not discriminate between struggling (peripheral) banks which need more liquidity and healthy (core) banks which can use these as a free lunch so to speak. Hence, the preferred policy would then seem to be to loosen the collateral rules once again to ensure ongoing peripheral access to ECB funding. Nevertheless, this overlooks the main attraction of the LTRO which is that it gives banks a much needed degree of certainty about future funding conditions.

In our view the use of the ECB‟s balance sheet will be very crucial in providing liquidity to sovereigns until the fundamental problems are to a large extent solved (which they will not be for a long time to come). The reason is very simple: The ECB is the only institution with unlimited firing power.

For the struggling peripheral sovereigns (Spain and to a lesser extent Italy) there are currently only two options:
- They keep partial market access as yields are supported by ESM or ECB bond buying
- They are driven into a full scale Troika program

The big problem is that policymakers have done everything they can to make the bond buying option as ineffective as possible. ESM bond buying may well backfire because the markets know that its resources are limited. There is an analogy here with a central bank trying to prevent a devaluation of the currency: Because speculators know FX reserves are finite, FX interventions become completely self-defeating as they are an open invitation to what is ultimately known to be a one-sided bet.

Meanwhile, ECB bond buying could actually drive yields up as well because ECB holdings are perceived to be senior and because the ECB is not willing to go at it full force. For markets it is not sufficient to know that a central bank has the ability to end speculation, they need to be convinced that it is willing to do so as well!

China: real stimulus coming through
Chinese data continue to reflect the weak domestic demand growth picture. June Inflation was a bit lower than expected, at 2.2%, down from 3.0% in May. Much of the decline can be explained by base effects. Last year in June and July, pork prices rose sharply. This is the main reason why food price inflation on a year-on-year basis fell by more than two percentage points. But next to the favourable base effects and less inflation coming from food and energy, we see the weaker demand picture clearly reflected in the inflation data. The month-on-month CPI rate was -0.6%, the third negative number in a row, after the -0.1% and -0.3% in April and May. Producer price inflation fell to -2.1% year-on-year.

Import growth fell to 6%, down from 13% in May. The decline looks worse than it really was, as May had more working days than a year earlier. Compared with the 7% average for the first five months of the year, the 6% recorded in June does not represent a dramatic change.

Export growth was a bit better than expected and stopped falling. The 11% recorded in June was even higher than the 9% average of the January-May period. More good news came from the housing sector. Social housing investment has been accelerating in recent months, in line with statements and announcements by government officials recently. For the first half of the year, 4.7 million new housing units were started to be built, which equals 63% of the 2012 year target. Particularly June was a good month.

After two months of accelerated policy easing, we are slowly seeing the evidence coming through. The June activity data and the Q2 GDP number are likely to be weak still, but from July onwards we expect Chinese growth numbers to start improving. With the Eurozone crisis ongoing and deepening perhaps, and global trade growth likely to remain weak, we expect that the Chinese authorities will continue with their accelerated easing initiatives. The Chinese recovery should strengthen in the course of the second half of the year.

Willem Verhagen - Senior Economist
Maarten Jan Bakkum - Senior Emerging Market Strategist

Weekly "Houseview Global Strategy" - ING IM
Read more, download the PDF (13 pages) below

houseview___11_juillet_2012.pdf Houseview - 11 Juillet 2012.pdf  (674.86 Ko)

Mardi 17 Juillet 2012

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