ECB May meeting and US non-farm employment report outline contrasting eurozone and US fortunes

Tom Tong07/May/2013Currency Updates

Markets eagerly awaited two key events last week: the ECB May meeting and the non-farm employment report out of the US. They were not disappointed. The ECB finally acknowledged the dismal state of the Eurozone economy and cut rates, extended full liquidity allotment, and announced “consultations” for further easing measures. By contrast, the strong US payroll report provided welcome respite from a string of softer than expected US data, and relieved fears of a Spring downturn in the US economy. The weak news underlined the vast macroeconomic gulf across the Atlantic: a moderate but strengthening US recovery, and a European economy stuck in what we refer to as “perma-cession”.


The string of positive surprises out of the UK continued last week. The key PMI business sentiment gauges for both manufacturing and services rose in April. The composite level is now at 52.4, a level consistent with the kind of slow growth we saw in the first quarter GDP report. There are also some signs that the monetary transmission mechanism has improved and SMEs in particular are seeing some positive impact from the Bank of England efforts to ease their access to credit. These improvements are probably enough to keep the MPC on hold at this week’s meeting, and we are very comfortable with our recently raised forecasts for a higher sterling against the euro.


We are issuing a special report with an in depth analysis of the ECB decision to cut rates last week. To summarize, the ECB decided to lower its main interest rate, the refinancing rate, by 0.25 to 0.5%. These moves have been widely (though not universally) expected by the markets. However, Draghi clearly intended to maximize the impact of the cut, and struck a distinctly dovish note during the press conference following the decision. Markets focused on Draghi’s apparent turn around on the matter of negative deposit rates; a possibility he now seems to accept. We regard Thursday’s decisions as modest, incremental, and mostly rhetorical steps in the right direction. Unfortunately, ECB policy continues to be hobbled by what we’d call “inertial optimism”: the need to sound a positive tone in order to justify lack of action. The second-half recovery in which Draghi continues to rely on is an increasingly remote prospect.

Perhaps of more long-term importance than the ECB cut is the subtle but persistent rhetorical shift away from austerity by a rising number of eurozone officials. Italian prime minister Letta and French president Hollande appeared to join last week with fairly explicit anti-austerity declarations. As long-standing opponents of misguided austerity, we think that these acknowledgements of economic reality are a welcome change, though we wait to see how the rhetoric is translated into actual policies before changing our views and forecasts.


Fears of a serious Spring slowdown in the US were eased by a fairly strong (by recent standards) non-farm payroll report. The US economy added 165,000 jobs in April. More importantly, the figures for the previous two months were revised up, March taken up by 50,000, and February by 64,000. The February revision pushes that month’s gain up to 332,000, the highest of any month since November 2005 (excluding the months boosted by Census hires in 2010). The separate household survey showed another drop in unemployment, to 7.5%. Strength in this all-important measure trumps the weaker readings from the PMI survey, all of which fell to year lows (though all of them remain above the 50 line separating contraction form growth). Continued strength in the housing market and a moderate speed up in the pace of job creation are consistent with our expectations of growth in the 2.5% to 3.5% range for 2013. Our view that the Fed will lead all other major Central Banks in the unwinding of unconventional measures looks to be well supported by evidence, and we expect this to provide support for the greenback vs. most other major currencies.


Written by Tom Tong

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