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SENTIMENT WON'T SWAY ECB WE SUGGEST: Repo rate to remain at 4% SUMMARY: Euroland economic sentiment edged down slightly in December. But it remains consistent with output growth around trend. Moreover, inflation developments – consumer and producer – as well as selling-price expectations in industry, all argue for retaining the current monetary policy stance. Euroland economic sentiment edged down slightly in December, dropping from 104.8 to 104.7. While the fall was minimal, it means that economic sentiment in the single currency zone now has fallen for seven consecutive months. Moreover, the fall was dampened by a surprising rise in Italian sentiment, which almost certainly will turn out to be a blip. By contrast, sentiment in both France and Spain fell, while it was flat in Germany. But it is the latter country that is currently the crucial one. If German sentiment – or, rather, activity – holds up, then overall Euroland growth should remain at least close to trend in 2008. In itself, therefore, the weaker economic sentiment is unlikely to shift the ECB’s stance towards easing monetary policy.
The ECB’s stance is more likely to be influenced by recent inflation data. The latest flash indicator showed December inflation at 3.1%, unchanged from November but well above the Bank’s ‘close to but below 2%’ target. While monthly deviations from the target can be disregarded, Euroland inflation has been rising steadily since August. Today’s business survey data also imply that inflation will continue to rise. The European Commission’s industry survey has a sub-index for selling-price expectations. This index has risen from 10.8 in October to 13.4 in December. Historically, a reading above 10 has been associated with inflation moving up above 2%. Moreover, there is also a good relationship between the direction of selling-price expectations and the direction of the change in inflation. Finally, Eurostat today also published the PPI for Euroland. In the year to November,
producer prices rose by 4.1%, more than double the 1.8% rate of two months earlier.
The recent surge in oil prices means that producer price inflation is likely to have
accelerated further in December. While the Euroland PPI historically is much more
The ECB’s stance will be strengthened by the fact that market interest rates have
responded positively to the concerted liquidity injection by central banks over the
holiday season. Where the spread between the ECB repo rate and three-month euro
euribor (long-term average: 20bps) rose to 95bps in December, it has now come down
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