With only 3 of 70 economists surveyed by Bloomberg expecting a rate cut at tomorrow's ECB press conference, Credit Agricole's Frederik Ducorzet suggests seven signals to watch for from Draghi that could signal ECB easing ahead. Crucially, as BofAML puts it, "further euro appreciation is a problem, particularly for the periphery," and with empirical Phillips curves in hand, there is little room for further compensation via wage reduction. In other words, if Draghi stands pat (or doesn't offer up some sacrificial forward guidance hint of easing being likely), the drumbeat of social unrest in the periphery will grow ever louder.
These 7 signals should be watched for carefully, according to Credit Agricole's Frederik Ducrozet, as hints that further ECB easing is on its way...
For ECB refinancing rate cut to be delivered in December, following conditions need to be met:
1. Explicit hint about rate cut discussion if asked whether decision was unanimous
2. Signal may be conditional on Dec. staff forecasts
3. Hint toward likely shift in balance of risks to price stability/reference to FX and oil prices on inflation
4. Keeping deposit rate at zero
Draghi may become more explicit on ECB’s liquidity plans:
5. Explicit reference to LTRO, reduction in reserve requirements or suspension of SMP sterilization may have greatest market impact
6. Market may be disappointed if ECB says it remains attentive to money market conditions without more details
7. Easy solution would be extension of fixed-rate full allotment regime in 2015
Which is crucial, for a s BofAML notes, while the euro is not overvalued, it is close to the upper end of its equilibrium range. Therefore, the euro area can afford a stronger euro, but not a much stronger euro. However, their evidence suggests a much lower euro threshold for the periphery, with little room to compensate with wage reductions.
Our estimates suggest that a further euro appreciation by about 3% in real effective terms would bring the currency to the early stages of an overvalued territory.
Moreover, the strength of the euro this year has already started offsetting the periphery's competitiveness gains, which the region achieved during a painful adjustment in recent years.
The chart above shows equilibrium estimates for the euro area and selective member countries, using the IMF's CGER methodology, which combines a number of equilibrium measures. According to our estimates, the euro is currently overvalued by about 7%.
However, our estimates also suggest that the euro could soon become overvalued if it continues appreciating. Moreover, the euro is already overvalued (beyond the ±10% range) from the point of view of Greece, Ireland and Spain. And PPP estimates suggest that the euro is overvalued by 20% against the USD.
The periphery cannot afford a much stronger euro
The strength of the euro is partly offsetting the competitiveness improvements that the periphery has achieved in recent years. Our estimates suggest that the euro is already too strong for Greece, Ireland and Spain, but within the equilibrium range for Italy and Portugal.
The Phillips Curve for euro-area economies has flattened substantially, which could make rebalancing more difficult, as countries require much higher unemployment (or output gaps) to achieve the same price adjustments. As wages are less reactive than before, peripheral countries need persistently high levels of unemployment to achieve rebalancing through wages.
In our view, there is little room to keep pushing through that route in countries with overleveraged households.