September or October? Does it matter?

It is a hard job to forecast the timing of future exchange movements. The ECB has left no clue when it will raises interest rates, leaving analysts baffled about whether it is going to happen in September or October. This is not a question of confused communication. The ECB itself does not know what it will do. This will depend on the data that are coming in between now and the next governing council meeting in September. If no further inflationary pressures surface, the rate raise will be postponed until October. We believe that the game is totally open after that. The market consensus of a 4.5% repo by year-end looks increasingly stretched, unless inflationary pressures build in the second half. This may, of course, happen, but it were to happen, then it would happen due to developments that are not yet clear.

 

The factors that may go against further rate rise are the exchange rate, which continues to strengthen, the fall in demand for property, which is already affecting the issue volumes of REITs, and have largely reduced the premium at which they are trading to net asset value. We believe that the eurozone is just past its cyclical peak, and it would be a mistake to raise rates unless there is concrete forward looking evidence of a build-up in inflation.

 

The overwhelming good news is that there is no pressure from the various wage rounds yet. The bad news is the flurry of reports about capacity shortages. There is further bad news from food prices, where a rise in global demand has brought new inflationary pressures. A central bank would not be wise to react immediately to a rise in oil or food prices, but this may be different if it suspected a structural shift, and/or strong second round effects.

 

We believe the outlook is genuinely open. If inflationary concerns prevail, and the ECB is forced to raise rates to 4.5% and beyond, we would expect a marked economic slowdown to take hold subsequently. So the outlook for inflation remains critical for future economic performance. Current policy is consistent with the ECB's 2% per cent inflation target (we ignore the "below-but-close-to" rhetoric). The monetary and credit data suggest perhaps another rise, but no more. The increase in interest rates has already had an effect on property prices, and the still strong rise in M3 is largely accounted for by portfolio shifts and hot inflows from abroad.

 

So prepare for 4.25% in either September or October, and then wait and see. If you must bet on year-end, throwing a dice is probably no worse than trying to reason your way to a hypothetical numbers.

Eurointelligence ECB Watch

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