Wed, 27/07/2005 - 08:00
The ECB is unlikely to cut interest rates over the next 12 months despite sluggish economic growth, according to Paris-based SG Asset Management. <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />
Michala Marcussen, the Group's Head of Strategy and Economic Research, believes the ECB is set to disappoint critics who believe the only way to boost growth and revive flagging confidence in the "European project" is to implement a rate cut. Speculation about the ECB's intentions has been further fuelled by the 50bps cut recently announced by the Swedish Riksbank.
Marcussen's central case is that current financial conditions, far from stifling expansion, are already very accommodative to growth, with the real key rate close to zero and long bond yields at historic lows. The recent depreciation of the Euro - down 6 per cent on a trade-weighted basis since the start of 2005 - has also contributed to easier monetary conditions, she says.
The other factor Marcussen views working against a cut is the yawning difference in GDP growth between Eurozone member states. Marcussen points out that <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Spain expanded by more than 3 per cent year-on-year in Q1 while Italy - increasingly under threat of deflation - contracted by 0.2 per cent.
There are similar levels of divergence in terms of inflation, according to Marcussen, a situation she attributes, in part, to different housing market structures. Countries with flexible structures would react most to a cut and, she believes, the ECB will want to avoid fuelling 'bubbly' markets, such as that in Spain.
Finally, Marcussen argues that, if it is accepted that weak growth is due to the slow pace of structural reform - and not monetary policy - there is no reason to believe that a rate cut would provide a solution to the structurally low growth of the Eurozone economy.
She also points out that there is growing concern that certain governments may be tempted to implement electorate-pleasing fiscal policies in the run up to forthcoming national elections.
"The case for a cut is not clear," says Marcussen. "Indeed, while market expectations clearly allow for the possibility of such a move, this has not yet been fully priced into the forward curve. For the ECB to implement a cut, we believe that economic indicators will have to take a significant turn for the worse and/or the Euro will have to undergo a sharp and abrupt appreciation. The case against this has real merit."
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