As markets gear up for the ECB meeting tomorrow the excitement (if ever there was any) is not so much about what the ECB does tomorrow (a sure hike to 4%) but moreso what hints will be given to future rate movements. In that respect there seems to be some internal squabbles at the ECB in terms of the future course of monetary policy and for how long the bank should stay in tightening mode. The debate pits Trichet and Weber from the Bundesbank against Noyer former president of the Bank of France and Drahgi from the Bank of Italy. The former, as we know, have their gaze firmly set on monetary aggregates (the M3) and future inflation pressures. The latter group on the other hand questions the validity of too much focus on liquidity and its merits as harbringer of inflation. From a governance point of view this is interesting since internal ECB differences to the extent that they have been there rarely, if ever, have been kept behind the doors. Rather, the governance issues have often been revolving around the EMU system itself where the ECB on many occasions has had to fend off criticism from member countries' finance ministers. Lately also the new president in France Nicolas Sarkozy have been poking the ECB for focusing too much on inflation relative to ensuring economic growth.
In terms of interest rate expectations and the actual course of the ECB markets already seem to have priced in hikes beyond 4% and perhaps even as high as 4.5% or 4.75%; futures markets implie a rate hike to 4.5%. Todays data on services further bolstered investors' confidence in rate hikes although of course the increase in the index was ever so slight. Yet, markets reacted accordingly pushing yields on 10 year Euro notes to a four year high. All this coupled with Bernanke's recent statement that the housing market will drag on longer than expected the EUR/USD rose to 1.3519 Dollars per Euro.
So, all my recent talk about losing steam in the Eurozone was way off base then? Not quite I think or at least I am not ready to concede just yet. However, in terms all those with money in the market it seems imprudent not to expect the ECB to go up to at least 4.25% in 2007 which means that long positions on the EUR/USD still seem to be the right bet. I remain slightly negative, however, on the downside as real economic data could tip into uncomfortably low numbers for some countries in the Eurozone which of course would revive what ever tensions exist behind the closed doors at the ECB. On the other hand I have to recognize that momentum both in Europe and globally is very impressive at the moment and the whole global economic edifice seems to be in a rare sweet spot at the moment. Lastly, it also seems as if I have lost a brother in arms regarding my pessimism on Eurozone growth and subsequently the ECB hiking aspirations. Consequently, Eurozone Watch withdraws their previous claim that the ECB should/would hold at 4%. Among the reasons cited for going beyond 4% are build-up of headline and producer price inflation as well as capacity constraints.
4% seems to be given and so does 4.25% at this point. I am taking a stubborn stance and since I have no money in the market it is of course exceedingly easy for me to remain slightly pessimisitic. As I have noted before I think real economic data will at best level off somewhat from now and perhaps surprise on the downside. Having said that though, a hike beyond 4% to 4.25% seems to be a sure bet at this point although I do think that growth could be sacrificed for inflation on that alter, but then again this is also what central banks are supposed to do I guess and indeed if global growth continues to power ahead the Eurozone could stay upbeat.