Continuing with our call since June that Draghi and the ECB would be on hold with changes to the main interest rate until at least the Fall, today’s decision by the ECB to keep rates unchanged was no surprise. Interesting, what has faded over recent months is a call for additional non-standard measures like increased lending facilities to small and medium-sized enterprises (SMEs) or talk of cutting the deposit rate to negative. We continue to think that policy measures of the ECB will continue to propel most Eurozone capital markets higher as underlying fundamentals remain challenged with only slight improvement in year-end.
Today’s mantra on the ECB conference call was a continuation of previous expectations, namely a gradual recovery in the back half of 2013, and Draghi reiterated more recent “forward guidance” that interest rates will remain at present or lower levels for “an extended period of time”.
Yet Draghi’s optimism around any great improvement in the economic outlook remains clouded. He lists underlying indicators of this recovery as export growth, recent gains in real income due to lower levels of inflation, improvement in confidence figures and PMIs, and deposit rates at levels last seen in 2007. Yet in the same breath he mentions at least equal downsides risks to this improvement: deterioration of global money and financing conditions, low credit growth, rigid labor markets, and the slow pace of economic reform at the country level.
Taken together, we expect economic performance to be challenged over the intermediate term, despite selective gains, and believe capital markets will continue to act favorably in response to the ECB’s interventionist policy stance (a continuation of the OMT policy announced a year ago) rather than in response to significant real improvements in the underlying health, which we do not expect in 2013. Our Eurozone growth forecast for 2013 is -0.8% to -0.6%. We expect credit conditions to remain clogged for a protracted period (more below), fiscal and labor reformers to be ignored or have little impact, and confidence and consumer spending to return only gradually in a backdrop of political uncertainty in Spain, Italy, and Portugal.
On the ECB adding minutes to its communication tools, Draghi signaled that there will be a proposal on minutes in the Fall.
- One cause for concern remains credit conditions across Europe. In the chart below we show ECB Loans to Non-Financial Corporations and Households. The former is near all-time lows at -2.3% and the latter has held at the low level of +0.3% for the past three months. We’re also hearing of more Eurozone banks (particularly in the periphery) report increasing non-performing loans, which will diminish credit quality and with it boost rates, further clogging the credit channel. S&P cut the ratings of 18 Italian banks just last week.
- Non-performing loans for Italian banks surged +22% in May from the same month of 2012 to €135.5 billion and lending by Italian banks to the private sector dropped -3.3% in June from a year ago to €1.6 trillion, according to the Italian Banking Association.
- Today’s Manufacturing PMIs proved mostly better in the July reading versus June. The Eurozone aggregate was 50.3 JUL (exp. 50.1) vs 48.8 JUN, which represented the first expansionary reading since July 2011. We expect some improvement in these levels into year-end.
- Eurozone Confidence Figures (Economic, Consumer, Business, Services, Industrial) for July were also stronger versus the previous month and have trended higher over the last three months.
Our critical immediate term TRADE lines of support and resistance are $1.31 and $1.33, respectively. Our intermediate term TREND Line is at $1.31, and we expect the cross to be range bound in August barring any political events that could shake the range.