Forgotten how much fun it is to interpret Alan Greenspan's seemingly indecipherable 1024 bit cypher during Q&A? Today, the ECB's Trichet, in a surprisingly incomprehensible press conference filled with equivocation and indecision, reminded everyone just how fun translation central planner talk can be. Luckily, SocGen's James Nixon has released a note helping us make some sense of Trichet's message. In addition, SocGen has now revised its expectation for an ECB rate hike from June to July. Alas, we are confident that when the time comes, July will become August, and so forth, until finally the ECB finally lowers the interest rate, a major slap in the face of the legacy JCT as he is about to replaced by Goldman's Draghi. Yet in the off chance we are wrong, and the ECB has merely taken a one month breather from hiking, today's 300+ pip plunge in the EURUSD could be the buying opportunity of a lifetime. Alas, for that to happen, we would like to see Goldman issue a sell EURUSD note first.
Revised ECB rate call: We are reluctantly revising our ECB rate call. After Mr Trichet’s failure to signal "strong vigilance" at this month’s press conference, a rate hike next month now looks unlikely. Instead, Mr Trichet merely reiterated that “We will continue to monitor very closely all developments with respect to upside risks to price stability.” This is exactly the same formulation as used in April. But it does seem to imply that the ECB has changed its communication policy, since the use of "monitor very closely" as opposed to merely "monitor closely" typically implies a rate hike in two months time. By failing to deploy the "strong vigilance" phrase, Mr Trichet apparently aimed to signal that the next rate hike would not come in June.
This said, Mr Trichet also seemed unusually at pains to leave the door open to an earlier move. In particular he noted a number of times that “we can increase rates whenever we judge it to be appropriate to do that.” He also repeated his usual mantra that the ECB is never precommitted.?
To rub salt into the wound, Mr Trichet then added another "very" into the fray, commenting that we will monitor the situation “very, very closely” and that this could not be interpreted as “a position of benign neglect." Certainly, it was particularly notable that all the other key code words in the introductory statement were unchanged. Hence interest rates (across the entire maturity spectrum) were described as "low", while monetary policy was described as still accommodative.
Moreover the ECB concluded that ‚we continue to see upside pressure on overall inflation? and stuck to the formulation that "risks to the medium term outlook for price developments remain on the upside.” This hardly looks like a change in stance and the ECB’s tightening bias remains firmly in place. Presumably, if the ECB were uncomfortable with negative real interest rates in April, then they remain equally uncomfortable with where rates are now, given that inflation has only increased in the intervening period. Asked about market expectations for two more rate hikes this year, Mr Trichet responded by saying that, “I have no other comment on market expectations which would go against the present expectations.”
What caused the change:
Why the change in tack? There seem to be three possibilities that could explain Thursday’s rather extraordinary press conference that so sharply dashed our and market expectations of a June hike. It is possible that the ECB has abandoned the practice of signalling its intentions in advance. Certainly Mr Weber was no advocate of the use of code words and it may be that, given the change in personnel on the Governing Council this view has gained some ascendancy. Given that inflation surprised to the upside at 2.8% in April – and that this level is now probably 0.5 percentage points above what the ECB might have been expecting as recently as March, it is hard to see how the ECB could stand by and watch this kind of increase in inflation go unchecked. Certainly it remains the case that next month’s ECB staff projections are likely to show a very significant increase in the ECB’s inflation forecasts – probably up to 2.7% in 2011 from the 2.3% forecast in March, and up to 1.9% from 1.7% in 2012. The magnitude of this increase, combined with what might yet be an exceptionally strong outturn for Q1 GDP, might yet convince the Governing Council to go ahead and raise rates in June. Hence the possibility of a June rate hike cannot be excluded. However it is hard to make this the central projection given that the use of code words has been one of the hallmarks of Mr Trichet’s Presidency and that "strong vigilance" has already been employed once in this tightening cycle.
The second possibility is that the ECB has decided to take a slightly more cautious stance than perhaps they envisaged in April. Certainly this would be consistent with the exceptional use of "monitor very closely" two month’s running. Possibly it is concerns about the renewed tensions in government bond markets and the talk of Greek restructuring that may have prompted the new found caution. Equally, despite the positive headlines on Portugal’s bailout package, it is important to appreciate that the program has not yet been agreed either by the Portuguese or the rest of the Europeans. Potentially the ECB could have taken the decision not to further muddy the water by announcing a rate hike this month. Having said this, in the past the ECB twice used the "monitor very closely" in consecutive months, before adopting a position of strong vigilance, ahead of the two rate hikes in the first half of 2007. So perhaps Thursday’s formulation is not that exceptional. The euro’s appreciation might also have played a role – certainly Mr Trichet made an effort to note the US administration’s preference for a strong dollar, which is a phrase he hasn’t felt the need to employ in recent months. Or the third possibility is that we simply got ahead of ourselves and a rate hike once every three months was always the intended trajectory.
We now look for the ECB to hike rates in July: Either way the central scenario now has to be to expect the ECB to hike rates by 25bp in July, October and January and we are revising our rate call to reflect this – i.e. we are simply sliding our entire profile back by one month. However we note that there is still a significant risk that the ECB might yet decide to hike rates in June once the Governing Council has sight of the latest ECB staff projections. Beyond this however, we continue to see the ECB as committed to a gradual normalization of interest rates, which we interpret as a desire to end the era of negative real interest rates and return real interest rates to a modestly positive level.
The other point of interest continues to be what the ECB intends to do with its money market operations beyond the June maintenance period. Asked what the ECB intended to do about the addicted banks, Mr Trichet only commented that this is a topic on which the Governing Council were still ‚meditating? and that said pointedly, that this had not been discussed at today’s meeting. This presumably will also be part of the rendez-vous for the June meeting, when all will be revealed.