EUROPE WEEK AHEAD: ECB, BOE, GER HICP, -IP, -FACTORY ORDERS, EZ ESI, -HICP, UK IP

 There is probably little to expect from the first ECB meeting this year, at least in terms of conventional policy measures. President Draghi said in a recent interview that, based on the latest data, he saw “no immediate need to act” on policy rates, further emphasising the encouraging signs in financial markets and the “progress” made by Eurozone countries. Other Governing Council members made it clear that they were comfortable with the current monetary stance given the ongoing signs of a gradual recovery – the ECB’s central case. Inflation probably holds the key for further action, but downside risks would need to materialise, in our view, for the ECB to act, ie, radical pre-emptive action looks unlikely for now. All in all, at Thursday’s press conference we expect Draghi to repeat that the ECB is maintaining an easing bias within its forward guidance framework, meaning that it remains ready to act to support markets and the real economy. However, we would be surprised to hear about concrete plans so soon. One key topic has been, and will remain, the management of liquidity conditions, as large LTRO repayments at the end of last year pushed excess liquidity down and term money market rates higher. But, on this topic as well, we suspect the ECB will not rush into temporary solutions but rather slowly build a consensus on the best tool(s) to deploy (we still expect a targeted ‘FLS LTRO’ at some point this year). One specific issue Draghi will definitively have to address as soon as next week is the repeated failure to sterilise SMP purchases due to a combination of falling excess liquidity, higher rates and financial fragmentation. More than ever, it would make sense to suspend the SMP sterilisation process and let the market adjust to those new conditions. With no inflation risks on the radar, including in Germany, it would be hard to argue that the ECB is taking any risk in doing so.

We expect Eurozone flash HICP to have stabilised at 0.9% YoY in December. Slightly stronger energy prices (0% YoY vs -1% YoY in November) will not be enough to balance the negative impact coming from a partial change in methodology in the German index (see below). Inflation in the Eurozone should remain weak in 2014 in our global scenario of both lower EUR and lower oil prices (see Economics Quarterly). Eurozone HICP inflation should remain close to 1% YoY during most of 2014, before getting closer to 1.3% YoY by end-2014.

We expect German HICP inflation to decline from 1.6% in November to 1.2% in December. This is mostly explained by a change of methodology in the calculation of prices for “accommodation services” and “package holidays”. Otherwise, goods and services inflation should remain weak.

European Commission economic sentiment indices will likely continue to increase in December. Contrary to PMI surveys, which are relatively more volatile, the ESIs have been on a steady upward trend over the second half of the year and will likely rise again in December for the eighth month in a row. We expect the ESI to increase to 99.3, which would be its highest level since July 2011, and an improvement to be reported in the manufacturing and services sectors. The PMI manufacturing index increased in December and, while the PMI services roughly stabilised, consumer confidence has ended 2013 on a firm positive note.

German factory orders are expected to have increased by 2.1% MoM in November, mirroring the decline registered in October. Notwithstanding high monthly volatility (especially in capital goods orders), the 3M/3M growth rate has been rising gradually over the past six months or so, broadly in line with the improvement in the PMI manufacturing new orders component. The recovery in factory orders suggests a positive near-term outlook for industrial production. We expect a 1.5% MoM increase in November, which would more than offset the -1.2% MoM contraction in the previous month and mitigate the negative carry-over effect for Q4, implied by the weakness in September and October readings.

The BoE will likely leave its key interest rate and asset purchase program unchanged at its January meeting, in the context of the three knockouts of the forward guidance announced in August. CPI inflation declined closer to the target, at 2.1% YoY in November, and GBP’s appreciation (5.5% over the past six months in trade-weighted terms) is expected to weigh down on inflation further out. Wage growth has remained subdued despite the faster-than-expected decline in the unemployment rate. The LFS measure of the unemployment rate decreased to 7.4% in October, a pace of decline that, if sustained, would imply the 7% threshold would be hit as soon as early 2014. The BoE will have to strengthen its forward guidance, either by lowering the threshold of 7% or, more likely, by a Fed-like adjustment to its guidance. The November MPC minutes already laid the grounds for such a change in communication by announcing that “there could be a case for not raising the Bank Rate immediately when the 7% unemployment threshold is reached”; a bolder announcement which explicitly extends the period of no-rate-hike will likely be needed in order to anchor market interest rate expectations.

UK industrial production is expected to have increased by 0.6% MoM in November. After a temporary and sharp setback in October, the CBI expected output survey edged up in November to a relatively high level at 24. Surveys in the manufacturing sector have continued to increase and the BoE’s Agents survey has reported steady growth in manufacturing exports to the US in particular (13% of total exports of goods), as well as to the Middle East and emerging markets. Despite the improvements in economic prospects, investment intentions have remained hesitant and mostly focused in the automotive and aerospace industries.

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