Weaker euro after the ECB

(04.02.2011) The euro slipped versus most currencies yesterday after a less hawkish than expected ECB dampened rate-hike hopes. Today the attention will be directed towards the monthly US non-farm payrolls figures.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

illustration euro cc DNB marketsThe euro weakened broadly after ECB's monetary policy meeting yesterday. Within a couple of hours it had for example slipped by almost a full percentage point versus the dollar. EURUSD is currently traded around 1.364, down from 1.379 yesterday morning. The Norwegian krone also gained versus the euro, and EURNOK has consequently dropped back towards 7.8.

ECB’s interest rate decision should not have surprised anyone – the refi rate was kept at 1 per cent. Trichet’s balanced description of the inflation outlook, however, was probably more surprising. At the last policy meeting the same Trichet was interpreted as fairly aggressive, after among other things cited the rate-hike in mid 2008. This seemingly hawkish tone raised interest rate expectations, which further contributed to a stronger euro.

Both the consumer and producer price inflation have risen since last time, which many expected would lead to a further sharpening of the rhetoric. Instead, Mr. Trichet repeated the assessment from the previous meeting. Most notably, the recent price increases, due to higher food and energy prices, has been broadly as expected. The inflation rate may rise even further over the next months, according to the ECB, but is expected to moderate again “around the turn of the year”.

As last time, Trichet stressed the distinction between the central bank’s conventional and unconventional monetary policy: The former is designed to provide price stability, the latter to deal with markets that are not working properly. In all, the monetary policy meeting strengthened the belief that there will still be long before the first rate-hike.

Yesterday's consumption figures also reminded us that the European recovery is still fragile. According to Eurostat, overall retail sales fell by 0.6 per cent from November to December, compared with an expected increase of 0.5 per cent (Reuters). Thus, it appears that private consumption experienced the first quarterly decline since Q3 2009. In any case, retail sales decreased with 0.6 per cent over the quarter. Recent consumer confidence figures indicate some improvements, but given the record high unemployment, subdued wage growth, tough fiscal tightening and rising consumer prices, it is hard to predict anything but a weak consumption growth going forwards.

Several macro figures were released also in the US yesterday. The ISM non-manufacturing index, among other things, improved much more than expected, from 57.1 in December to 59.4 in January – a level not seen in five year. At face value, the index is now consistent with a GDP growth around 4 per cent. Furthermore, new figures from the labor market suggested that initial claims fell from 454’ to 415’ last week. Positive, although we do not put much emphasis in these weekly figures which fluctuate a lot.

Later today, however, we will get a more comprehensive and reliable indicator from the US labor market in the form of the monthly non-farm payrolls figures. In December the employment growth was much weaker than expected beforehand, only rising with 103’ persons. On the other hand, the unemployment rate from the Household survey dropped more than expected, from 9.8 to 9.4 per cent. According to the consensus estimates compiled by Reuters it is now expected that non-farm payrolls increased by 147’ in January. Our own estimate is significantly lower, with a gained of only 80’ persons. Furthermore, we expect a marginal increase in the unemployment rate from 9.4 to 9.5 per cent.

After Wednesday’s encouraging ADP-employment figures (there are often large discrepancies between that report and the non-farm payrolls) as well as improvements in the ISM index for both the manufacturing and the non-manufacturing sector, there is probably some upside risk in our estimates.

Anyhow, the economic recovery has not yet gained enough strength to bring unemployment substantially down, which was the major motivation for the Fed’s QE2 measures launched November last year. Governor Ben Bernanke reiterated that message when he spoke in Washington yesterday. Even if the Fed sees increased evidence of a self-sustained recovery in consumer and business spending, it still expects only a very gradual decline in unemployment.