We are going to have a busy end to this week despite the US public holiday on Friday. The ECB will meet today, but will likely keep its policy rate unchanged. On the “non-standard” easing front, we expect more details on the purchase of covered bonds. Moreover, after allotting 442.2 billion euro 12-month loans last week, we would like to see if the central bank will clarify any shift in policy from monitoring short-term to long-term rates.
Also on Thursday, the US labor department will release June's employment report. While the unemployment rate should have been on the rise, the pace probably moderated. We also anticipate better-than-expected non-farm payrolls data given the stabilization in jobless claims in recent weeks.
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The ECB will leave the main refinancing rate at 1% for the second month and should maintain the current program of buying euro-denominated covered bonds unchanged. In the accompanying statement, we believe the central bank will state that current rates are “appropriate” despite the refusal to comment if that's the floor yet. We also await more details regarding the covered bond purchase program.
Moreover, forecasts on economic growth and inflation will more or less be the same as in the previous meeting. In June, the staff projection came in lower than forecast. The mid-point forecast for 2009 GDP was revised down to -4.6% (between -5.1% and -4.1%) from -2.7%, as projected in March. For 2010, GDP was anticipated to have contracted -0.3% (between -1% and +0.4%), compared with March's estimate of 0%. Concerning inflation, CPI was forecast to ease to +0.3% (between +0.1% and +0.5%) and +1% (between +0.61% and +1.4%) in 2009 and 2010, respectively.
Last week, the ECB allotted 442.2 billion euro in the first 12-month open market operations—the most it has even allocated in an auction—at current interest rates of 1%. All bids were filled and 1121 banks participated. Compared with 12-month Euribor (Thursday's close at 1.53%), the fixed rate at 1% is very low and will likely lead to a further decline in overnight and long-term money market rates.
The ECB also allotted loans in the three-month operations, however, the amount was only 6.4 billion euro. This move indicated that the central bank might want to lower long-term funding costs, rather than the short-term ones. Going forward, ECB may focus on 12-month open market operations, together with the purchase of covered bonds, as non-standard tools to revive the 16-nation region's economy. In this sense, we believe the probability for another rate cut in the second half of the year has greatly reduced.
The euro zone probably entered negative headline inflation in June and we expect the ECB will keep interest rates at 1% for a protracted period of time.
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US Employment Report
While the consensus forecast for the non-farm payrolls figures have declined -375K in June after a -345K drop in the prior month, we believed there may be pleasant surprise given the fall in jobless claims. Though initial jobless claims unexpectedly rose to 627K in the week ending June 20, the four-week average has plummeted 42K from the peak. Moreover, continuing claims have shown stabilization recently, as driven by an increase in hire rate.
However, as continuing claims continued to stay at record high levels, it's likely that the unemployment rate would have risen further in June, though at a pace slower than in previous months. The market anticipates that unemployment will rise to 9.6% in June from 9.4% a month ago, with the tendency of reaching 10% by the end of the year.
A huge decline in payrolls was probably found in the motor vehicle sector due to layoffs in Chrysler and GM. However, it's unclear if the respective 27K and over 10K job losses were counted in May or June. Therefore, we are not sure if a big drop in manufacturing employment would have been recorded this month.
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By the Staff of ActionForex.com
