ECB and Riksbank: no exit strategy in sight

The ECB and Riksbank will announce tomorrow (Thursday 3 September) their monetary policy decision. Both Central Banks are expected to leave rates unchanged (at 1% and 0.25% respectively) and to adopt a wait-and-see stance. Following the encouraging economic signals coming from the French and German economy in the last few weeks (both countries saw positive GDP growth rates in Q2), the ECB will likely revise up its growth estimates for the Eurozone in 2009 and 2010. No major changes are expected for inflation projections, as the CPI development in the last few months has been in line with estimates.

However, a revision of growth estimates should not change the short/medium term monetary policy outlook. Indeed, many ECB Governing Council members are looking at the recovery under way with a lot of scepticism. As an example, ECB President Jean Claude Trichet during the Federal Reserve Bank of Kansas City's Annual Economic Symposium in Jackson Hole said that “we see some signs confirming that the real economy is starting to get out of the period of freefall, but this does not mean at all that we do not have a very bumpy road ahead of us.”

Therefore, we continue to believe that an ECB’s exit strategy from the current expansionary monetary policy is far from close. As we have indicated in the article Does the ECB really need an exit strategy? The Euro/Dollar exchange rate factor… the Taylor rule illustrates that the need to raise rates should not materialise for several quarters and our monetary condition index (MCI), which considers the real exchange rate and short-term rates trend, remains well above the long-term historical average. The MCI would worsen in the coming months should the Euro increase further and/or inflation rebound. Furthermore, a tightening role for the Eurozone economy has been played since last March by the single currency’s appreciation.

The scenario in Sweden is not that different. Having cut rates to 0.25% and introduced negative interest rates on deposits in July (commercial banks must pay 0.25% for the privilege of saving their money at the central bank), we do not see the Riksbank launch new expansionary measures at this week’s monetary policy meeting. We also believe that the Riksbank is still far from announcing an exit strategy. With the economy expected to moderate by 5.4% in 2009 and to edge up by just 1.9% in 2010, low rates are key to stimulate the economy. By contrast, higher rates would likely reinforce the Swedish Krona’s upward trend, which would weigh on exports. Pending the release of more details from the ECB and Riksbank meetings, we do believe that rates will remain unchanged until the middle of 2010 for both CBs.