Currency and interest rate market newsletter samples

The ECB will inevitably be concerned over deteriorating growth indicators within the Euro-zone and referendum rejection will hurt confidence. Underlying inflation remains under control and there is the potential for a lower headline rate over the next 2-3 months. Given the inflation trends, there should be little risk in cutting interest rates. Money supply growth is, however, firm and the economy will be given a stimulus by the Euro’s decline during 2005.

The ECB will react strongly against external interference and any overt political calls for rate cuts or ECB criticism will be counter-productive. The weaker Euro will also provide a policy stimulus and, in this sense, a rate cut would make little sense at this point. It would be better for the central bank to wait and assess economic trends over the next 1-2 months at least This would also give the ECB more time to judge the longer-term currency-market impact of political stresses.

Internationally, the ECB can also wait to assess wider growth trends and Federal Reserve policy. It would be easier to sanction a rate cut if US rates appeared to have peaked. Overall, there is a slightly greater risk of a rate cut, but policy stability still looks the most likely outcome in the short term.

The ECB has held short-term interest rate at 2.0% for 2 years, an extended period of stability. So far during 2005, the ECB has also ruled out the possibility of an interest rate cut and was looking for an opportunity to increase rates. Events over the past week will, however, spark renewed speculation that the central bank will be forced to cut interest rates in the near term. At the June 2nd policy meeting the bank left interest rates at 2.0% and also expressed optimism that the economy would recover gradually.

The economic data has remained gloomy with the Euro-zone PMI index for the manufacturing sector weakening to 48.7 in May from 49.2 the previous month. The decline below the crucial 50.0 level indicates that the manufacturing sector is contracting. There was a significant deterioration in the French and Italian economies while Germany recorded a marginal recovery. Business confidence has weakened consistently over the past month while the labour market remains weak with French and German unemployment above the 10.0% level.

The headline inflation level is in line with the ECB’s 2.0% target, but underlying inflation, excluding the impact of high energy prices, is running at 1.4%. Headline inflation has the potential for a slight decline and inflation control will increase the potential for lower borrowing costs. The ECB in its latest forecasts pushed the 2005 inflation forecasts slightly higher, but lowered the 2006 forecast to a 0.9-1.6% range.

There have been calls for lower interest rates from organisations such as the OECD over the past week, while German institutes have also called for lower borrowing costs.

The political stresses resulting from Euro-zone political difficulties will increase pressure for a cut in interest rates. European politicians will be concerned that low growth rates have been crucial in increasing opposition to the new constitution. National governments will also see the ECB as an easy target to blame for weak growth and in seeking to deflect attention away from the political difficulties.

The ECB will, however, react very badly to political pressure and criticism of the bank will tend to reinforce opposition to an interest rate cut.

The money supply indicators do not suggest that policy is too restrictive at current interest rate levels with annual M3 money supply growth comfortable at an annual rate of around 7.0%. The significant Euro decline since the end of 2004 will also provide a significant monetary stimulus to the Euro-zone and will reduce pressure for lower interest rates.

In historic terms, policy is also still expansionary with real interest rates close to zero and the ECB has been looking for opportunities to return interest rates to a more neutral stance at around 3.0% rather than contributing to an extra stimulus.

On economic grounds alone, the referendum rejection has provided a further small policy stimulus through a weaker currency. Although this will be offset by a potential deterioration in business and consumer confidence, the ECB can afford to wait and assess the impact of a weaker currency. There is little immediate reason to provide an extra monetary stimulus through lower interest rates.