• We remain comfortable with our “moderate recovery” story. Weak GDP at end-2009 and still contracting domestic demand vindicate our cautious growth forecasts. 1Q GDP is a tricky call, with a weather-related drag on construction and stronger-than-expected IP momentum offsetting each other. We stick to our view that GDP will be up 1% qoq annualized in the first quarter, and 0.9% on average this year. 2011 is still seen at 1.3%.
      • Recent tensions in the sovereign debt market have strengthened evidence that external imbalances need to be taken seriously into account. Divergences in current account balances and competitiveness can lead to the build-up of dangerous disequilibria within the euro area, which could prove costly to fix. We show that there is room for the laggard countries to take an active role in the adjustment process, accelerating structural reforms and boosting productivity.
      • The debate about the necessity for peripheral countries to correct large current account deficits often relies on the idea that the optimal adjustment process requires a significant devaluation of the exchange rate. In fact, we found evidence that this would not represent a “good-forall” recipe to correct imbalances. In contrast, flirting with the idea that currency devaluation will provide a quick fix to peripheral countries’ problems risks backfiring if it lowers governments’ commitment to reform.
      • We left unchanged our CPI forecasts at 1.3% in 2010 and 1.8% in 2011, also confirming the main trends: rising energy inflation, low pressure on food prices for some time, and further core disinflation. We elaborate on the relationship between economic slack and core CPI, showing that a survey-based measure of the output gap built with an a priori assumption on the potential growth rate of the economy provides helpful information to forecast core prices. However, we also argue that it’s very difficult to find a stable relationship between the output gap and core inflation.
      • Against a background of tensions in the sovereign debt market, the ECB is taking a very cautious and pragmatic approach to its exit strategy. The focus remains on shortening the duration of outstanding liquidity while ensuring that the liquidity remains abundant. However, in the coming months the ECB is likely to face a trade-off between keeping policy rates on hold for a lot longer and risking an abrupt upward adjustment in market rates.
      • FI: The new set of measures unveiled by the ECB aims at calibrating the exit strategy to liquidity needs of the financial system. The drain of excess liquidity in the coming months will be very gradual, keeping the EONIA in the 0.35% area at least until end-September. The return of the EONIA to the refi rate area is likely to happen only at the turn of the year. Bond-wise, central banks’ cautious approach will keep demand strong, especially at the front end. The curve should remain steep, with the beginning of the flattening trend in 4Q.
      • FX: Tactical trading in the absence of any profitable trend will be the name of the game on FX majors until EMU concerns definitively abate. Major central banks keeping key rates on hold will also contribute to extending the current stalemate.