Market Economics | Interest Rate Strategy - BNP PARIBAS ...

The nominal policy rate and nominal growth are also
out of whack (Chart 5). This was the case through
most of the economic expansion from 2003 to 2008
which the ECB, retrospectively, probably sees as an
error. The slow pace of the rate rises from December
2005 was a contributory factor to the decision to hike
in July 2008 as inflation was surging and breakeven
inflation rates were well north of 2%.
The exceptionally low level of policy rates will be one
of the main arguments put forward by the more
hawkish members of the Governing Council in favour
of a tightening sooner rather than later. We are
already hearing from some members that the risks
associated with tightening too late are greater than
the risks of tightening too soon. We see this as the
view of a very vocal minority. We doubt that there
would be sufficient support on the Governing Council
to justify a rise in interest rates on these grounds
while domestically-driven inflation pressures remain
contained, given the potential adverse effect on the
most distressed member states’ economies and
financial sectors.
It is one thing for the Governing Council to reach
agreement to deliver a warning shot over inflation
and threaten to hike rates to make sure inflation and
inflation expectations stay in check. It is another thing
altogether, in the current uncertain economic and
financial circumstances, to agree to hike rates.
In credit
Trends in money and credit growth will also be an
important influence on how ECB policy evolves. The
assessment in the most recent press conference and
Monthly Bulletin do not point to any pressing need for
a tightening of policy. Broad money and bank lending
growth rates have begun to normalise but they are
far from normal.
As Chart 6 highlights, bank lending growth was a
reasonably good guide to ECB policy developments
in the first decade of EMU, albeit with a considerable
lag between lending growth and policy changes. On
the basis of how we expect lending growth to evolve
from here (which is a relatively optimistic forecast),
the lags suggest that the refinancing rates ought not
to start rising until spring 2012.
The relationship broke down in 2009, with the ECB
slashing rates much earlier than would be implied by
bank lending growth. It could be argued that this is a
reason why the ECB might want to start increasing
rates earlier than in the past – linked again to the
‘normalisation’ concept.
Chart 6: ECB Policy & Bank Lending
13
BNPP Fcast
5.0 Bank Lending (% y/y, 18Mth Lag RHS)
12
11
10
4.0
9
8
7
3.0
6
5
2.0
4
3
2
1.0
ECB Refi Rate (%)
1
0
0.0
-1
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
Source: Reuters EcoWin Pro
Table 1: Key Forecasts
2011 2012
(%) 2010 2011 20122013 Q1 Q2 Q3 Q4 Q1 Q2
GDP y/y 1.7 1.6 1.6 2.0 2.1 1.6 1.5 1.5 1.5 1.4
HICP y/y 1.6 2.2 1.6 1.6 2.3 1.9 2.2 2.3 1.9 1.7
Core HICP y/y 1.0 0.9 1.1 1.6 1.1 0.9 0.9 0.9 1.0 1.0
ECB Refi Rate 1.00 1.00 1.75 2.75 1.00 1.00 1.00 1.00 1.00 1.25
Source: Reuters EcoWin Pro
Note also that our current forecasts for the y/y growth
rate in bank lending imply that the refinancing rate
should rise to around 3-3½% in our forecast horizon
out to 2013, below the 4% peak in the 2005/8 cycle.
Bottom line
The level of anxiety at the ECB over the upside risks
to inflation has increased and the risk of an earlier
start to the tightening cycle than we have forecast
(i.e. from Q2 2012) has risen accordingly. While the
ECB still expects inflation to remain in line with its
definition of price stability over the medium term, it
intends to monitor the various risks to this scenario
very closely – as will we. Two key influences on
whether the threat of action will actually translate into
a higher refinancing rate this year, which markets will
continue to price in while inflation is above target, will
be developments relating to second round effects on
inflation and the evolution of inflation expectations.
On the basis of our assessment of those and other
economic and financial developments going forward,
we conclude, on balance, that the ECB’s bark is
likely to be worse than its bite.
Ken Wattret 20 January 2011
Market Mover
21
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