On Thursday, the European Central Bank will be delivering their first monetary policy announcement of 2010. In anticipation, the Euro has given up some of its earlier gains in anticipation of the central bank meeting. The ECB is not expected to alter interest rates but the market will be looking for any information on whether the central bank’s stance has changed given the recent fiscal problems of its members nations. Greece’s survivability is a sensitivity issue and any other central banker would probably avoid talking about the topic. However Trichet is not just any central banker and may instead take this opportunity to criticize member countries for not getting their fiscal house in order. Nonetheless, if Trichet even hints that fiscal problems play a role in their decisions on monetary policy, the euro could give up more gains.
The latest round of economic data provides little to persuade ECB officials to make definitive commitments on rates and exit strategies. The primary weak point remains rooted in the struggling employment markets. December saw the Euro-Zone’s unemployment rate reach 10.0% for the first time since the region was established. As a result, Retail Sales plunged -1.2 percent. However the increase in manufacturing and service sector PMI provide hope while higher energy prices have boosted inflationary pressures. Based upon the mixed economic reports alone, the ECB may not have enough sufficient reasons to be more hawkish:
Here is a look at how some of the key Euro-zone data have fared since the last monetary policy meeting:
Last month, the ECB took its first steps to scale back extraordinary measures. At that time, the ECB said “the governing council will gradually phase out, at the appropriate time, the extraordinary liquidity measures that are not needed to the same extent as in the past.” This included a definitive timeline of the end of March to end liquidity operations. Nevertheless, this move did not exactly signal any shift on the topic of rates, which were described as “appropriate” at the time of the meeting. This confirms a strict timetable regarding rates as we will probably not be privy to any new information until the second quarter.
Among the many issues that the ECB will grapple with tomorrow, the most important will be the circumstances surrounding Greece’s financial health. The whole situation with Greece has added a black stain to the European recovery. If in fact, the country is unable repay debts, the ECB will be looked to as the key to staving off an economic crisis. Even though any bailout has been ruled out by many EU officials, it is questionable if their rhetoric will be maintained if the worst case scenario comes to fruition. The ECB lends to Greek banks and many non-Greek Eurozone banks also have exposure to Greek debt. Therefore, Trichet could err on the side of caution tomorrow. It may be difficult for the central bank to start tightening if certain member nations are still deep within the clutches of recession. Therefore we don’t expect too much from the ECB tomorrow. Since they have already laid out initial plans for how they will deal with extraordinary policies and the uncertain environment leaves any hawkish comments about rates doubtful, the first ECB decision of 2010 may be an uneventful one.
The following chart illustrates how the EUR/USD has performed following the last 3 monetary policy meetings which are marked with arrow.
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