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ECB Maintains Status Quo in July

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Written By: Miles Pearson – Forex Focus

Eurozone economy continues to expand, but the central bank remains cautious.

Economic activity in the euro area continued its upward momentum, with most of the economic indicators showing a robust increase in economic activity—with the exception of inflation numbers. However, the European Central Bank (ECB), concluding its most recent meeting on July 20, 2017, did not share the enthusiasm of the markets as they voted unanimously to leave key interest rates unchanged at 0 percent and indicated that they are willing to increase the size of the stimulus package in case the economy heads south.

Before commenting on the stance taken by the central bank, let’s look at some of the recent key economic numbers from the eurozone.

Q1 2017 GDP: 

The economy expanded at the fastest pace since the first quarter of 2015, rising 0.6 percent in the first quarter of 2017, following a 0.5-percent growth in the previous two quarters respectively and beating market consensus of a 0.5-percent rise. On a year-on-year basis, too, gross domestic product (GDP) figures outperformed with a robust 1.9-percent growth compared to expectations of a 1.7-percent rise and slightly higher than the 1.8-percent reported in the fourth quarter of 2016.

The following graph highlights the quarter-on-quarter GDP numbers for 2016 and first quarter 2017.

Source: EUROSTAT

May unemployment rate:

The seasonally adjusted unemployment rate in Europe was at 9.3 percent in May 2017, sharply down from 10.2 percent a year earlier and unchanged from the previous month. Since then, the unemployment rate in the European Union (EU) has steadily declined. The Czech Republic and Germany reported the lowest rates of unemployment at 3.0 and 3.9 percent, with the largest number of unemployed seen in Spain at 17.7 percent.

The following chart illustrates the monthly unemployment numbers for 2017.

Source: EUROSTAT

May retail sales:

Inflation-adjusted retail sales in May were better than expected, with the actual reading coming in at 2.6 percent year-on-year, unchanged from the previous month. The retail sales figure, which is an indication of consumer spending, was better than the 2.3-percent projected by market experts and about 40 percent higher than the May 2016 number. Retail-sales figures in the last three months have shown steady growth, but there is still some distance from the October-November figures of last year. 

Illustration of the monthly retail-sales numbers for 2017:

Source: EUROSTAT

July Markit Flash eurozone PMI:

The manufacturing PMI (Purchasing Managers’ Index) in the eurozone for the month of July declined to four-month lows. The flash index recorded a growth of 56.8, slightly lower than the 57.4 figure in June. The diffusion index was below analysts’ expectations; they expected a reading of 57.2, but above the 50-mark that differentiates between expansion and contraction in the manufacturing sector. Growth in the export order book, rate of job creation and average prices for goods continued to rise at a slow pace, while growth in new orders and backlogs in work slowed down a bit.

The services PMI likewise stood at 55.4 in July, almost in line with market projections of 55.5 and unchanged from the previous month. The PMI activity in the services sector is at the lowest since January this year but well above the levels seen in 2016. Employment and average prices paid for services registered an increase, but at a slow pace. 

June Consumer Price Index (CPI):

Eurozone CPI remained unchanged at 1.3 percent year-on-year in June as energy prices continued to linger at multi-year lows. The reading was in line with analysts’ expectations but below the ECB target of 2 percent. Core consumer inflation, which ignores volatile energy and certain food prices, rose moderately to 1.1 from 0.9 percent in May. Consumer prices have remained low for the last four years, with the index rising in line with the ECB’s reference of 2 percent in February this year. However, average consumer inflation in 2017 has increased steadily compared to the last four years.

The following chart highlights the Eurozone Consumer Price Index in 2017.

Source: EUROSTAT

The ECB over the last couple of weeks has been flip-flopping when it comes to the outcome of the stimulus measures, confusing markets and increasing currency volatility. Prior to their meeting on July 20, there were hawkish comments from the ECB chairman indicating that the ECB would reverse its easy-money policy. However, the issue was quickly laid to rest after the ECB issued a dovish statement following its policy meeting. Addressing the press conference later in the day, ECB President Mario Draghi stated that ECB members would take a look at the bond-purchase program in September, striking up a more neutral stance.

One thing is certain: interest rates in the 19-nation euro area are not going up anytime soon, although some of the countries led by Germany and the Netherlands back an end to the bond-buying package and prefer higher interest rates—while the ECB expects inflation, which is way below the central bank’s target of 2 percent, job creation and wage growth to normalise in the coming months. If that happens, we could see some action from the ECB; until then, there’s nothing much that Europe’s central bank is willing to do other than continue with the ultra-easy policy.

Will interest rates in Europe continue to remain at 0 percent, where it has been for the last one and a half years? We will know for sure in September.

 

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