ECB preview: Dovish $FXE

Since the last Governing Council meeting, macroeconomic data has been soft and concerns about Greece remain high on the agenda. With this background, we expect that the ECB will be rather dovish. Rates will of course remain on hold.

• The ECB is eager to continue with its exit strategy, but sees no need to “rock the boat” just now. We thus expect that the ECB will continue with full allotment at both the main refinancing operations and the one-and three-month auctions throughout Q2.

• We expect that the final 6-month auction will be at 1%. There is a small risk that the ECB will opt for an indexed rate as they did with the 12-month auction in December, but it doesn’t really matter, as a rate hike within six months is unlikely.

• The new ECB staff growth projections will be broadly unchanged, which reflects that the disappointing GDP growth in Q4 09 is countered by a slightly more positive assessment of growth prospects for 2010.

•Trichet may say something along the lines of ‘whether euro area government bonds can be used as collateral at the ECB is not determined solely by rating agencies.’ This could be applied to Greek government bonds.
No need to “rock the boat”

Since the last Governing Council meeting, macroeconomic data has been soft and concerns about Greece remain high on the agenda. The tiny GDP growth in Q4 09 brings forward concerns about whether the euro area is decoupling from the global recovery. We don’t think so, but the prospect of fiscal tightening in many member states before domestic demand shows a sign of a strong recovery is not a comforting one. In addition, the monetary analysis does not give reason to lean against the wind yet. Monthly loan flows to households are in positive territory but loans to non-financial corporations remain negative. On a positive note, the continued decline in EUR/USD has improved Euroland export prospects and PMI new-export orders have been rather upbeat. With this background we expect that the Governing Council will be rather dovish. Rates will of course remain on hold at the March meeting and the ECB will not signal any rate hikes in the near future.

Any change to the “current rates remain appropriate” or signal that rate hikes are not far away would result in sharply increasing short rates, a flattening of the curve and a strengthening of the euro. We expect the first hike in November and rate hikes throughout 2011 but there is a fair chance that the ECB will decide to pause if substantial fiscal

1. tightening takes place.

ECBDovish