|
Eurozone: Plunging Confidence = Faster ECB Cuts? (powered by Bank of America) |
|
24.11.08 14:24 |
| | | Eurozone: Plunging Confidence = Faster ECB Cuts?
- Amid mounting turmoil in many financial markets, the Eurozone economy seems to be sliding into its worst recession in decades. Following the sharp drop in sentiment among Eurozone purchasing managers reported on Friday, German Ifo business confidence today fell much more than expected as well. The dismal confidence data project that the German and Eurozone economies will contract by more in 2009 than they did in 1993.
- The plunge in business climate will not be lost on the European Central Bank. Although the ECB is not known for aggressive rate moves, the chance that the ECB may cut rates by 75bp rather than the usual 50bp on December 04 has now risen from 40% to 65% in our view. We now expect ECB rates to hit a trough of 1.5% instead of 2.0% by April next year.
German Ifo: Plunging at Record Speed
Amid mounting turmoil in many financial markets, the Eurozone economy seems to be sliding into its worst recession in decades. Following a sharp drop in the sentiment among Eurozone purchasing managers reported on Friday, German Ifo business confidence today fell much more than expected as well, hitting its lowest level since the 1993 recession. At 85.8 in November 2008 after 90.2 in October, the level of German Ifo business confidence is still just above the 84.8 trough of February 1993. However, the pace of decline is now even more breathtaking than it had been in 1992/1993. Within six months, the Ifo index has now lost 18.5 points. In the worst six-month period in 1992/1993, confidence had fallen by 12 points.
German businesses are increasingly concerned about their current situation. The current conditions component of the Ifo index declined by more than 5 points in one month from 99.9 in October to 94.8 in November. This is still well above the previous cyclical troughs of 83.0 in May 1993 and 83.9 in January 2003. As firms can still work on orders they received in late 2007 and early 2009, the decline in output so far is not yet as deep as it had been in the last two recessions. However, Ifo business expectations for the next six months fell from 81.4 in October to 77.8 in November. This is the lowest level on record since the start of the pan-German Ifo survey in 1991. Ahead of the 1993 recession, Ifo business expectations had hit bottom at 83.6 in November 2002.
The speed of the recent drop in business confidence as a whole and the record low for forwardlooking expectations suggest that 2009 will likely be noticeably worse than the 1993 recession, when GDP declined by 0.8% for the year as a whole in both Germany and the Eurozone. We see a downside risk to our forecasts that the German economy will contract by 1.2% and the Eurozone economy by 1.1% next year.
The details of the German Ifo survey offer little consolation. Confidence fell markedly in all four major sectors, with the declines in manufacturing and retailing more pronounced than those in construction and wholesaling. According to the Ifo institute, German manufacturers expect their export business to weaken at an accelerated pace and are planning to reduce their headcounts. Unfortunately, not even the much lower oil prices seems to provide consumers much cheer. Lower confidence in the retail sector ahead of the crucial Christmas shopping season suggests that consumers will not spend the windfall gain from lower oil prices but will raise their savings rate instead as they worry about losing their job.
Collapse in Confidence Supports Case for 75bp ECB Cut
The sharp deterioration in business climate will not be lost on the European Central Bank, in our view. The ECB is not known for aggressive rate changes and has never done more than a 50bp move. But with the plunge in the Eurozone PMI and the German Ifo, the probability that the ECB may cut by 75bp to 2.5% on December 04 has now risen from 40% to 65% in our view. The massive downward revision to its own projections for growth and inflation to be presented in December could give the ECB the opportunity to explain the unusually steep cut then. We look for the ECB to take down its 2009 GDP call from 1.2% in September to -0.5% or less, and slash its 2009 inflation call from 2.6% to 1.6% or less. If so, the ECB would still be above our own forecasts of a 1.1% decline in 2009 GDP and an inflation average of a mere 1.3% for 2009.
We change our rate call accordingly. If the ECB cuts by 75bp in December, the bank may pause in January before easing policy again by 50bp in February. Many at the ECB seem to blame the current financial turbulences on the legacy of an overly loose monetary policy earlier this decade. The ECB is thus reluctant to bring rates down to record lows. We look for ECB hawks to firmly resist a cut below the previous trough of 2% for a while. However, if the economy really weakens by as much as the record low in Ifo expectations now suggests, and if inflation indeed falls to 1.5% by February next year on its way to a trough just above 0% in mid-2009, chances are that the ECB will react to these unusual circumstances by easing policy further to 1.5% in April. We now project ECB rates to bottom at 1.5% instead of 2.0%.
Of course, once the economic emergency is over and the economy starts to recover, the ECB will probably not hesitate to bring rates back up to more normal levels. We look for the ECB to start taking back its huge monetary stimulus before the end of next year.
The ECB itself does not seem to have made up its mind yet about the size of its coming cut. One recent ECB speaker seemed to imply the chance for a big cut (Weber), others (Gonzalez Paramo; Mersch) still pointed to the usual 50bp move. However, the current avalanche of bad data could well swing sentiment at the ECB towards the unusual 75bp move. We consider it fair value for markets to price in about 65bp of easing for December 04. If the ECB sticks to its usual 50bp move in December, the bank would likely try to limit any potential market disappointment by indicating in its subsequent press conference that it will probably ease significantly further in early 2009.
source: Bank of America
| |
|