• The focus of the ECB now appears to be shifting from whether to implement more stimulus measures to when to begin withdrawing them.
  • We believe that the euro area next summer will have recovered so much that the ECB will consider interest rates at historical lows as being inappropriate and will start hiking.
  • When the ECB starts hiking it will probably deliver about 0.5 percentage points each quarter, which was the average hiking speed seen in the 2000-01 hiking cycle.
  • The exit strategy is likely to begin with alterations of the conditions for the long-term refinancing operations.

The focus of the ECB is shifting toward an exit strategy

On August 19, Governing Council member Axel Weber said to the German newspaper Die Zeit that it is too early to withdraw stimulus measures. We fully agree with that, but while some misinterpreted this as meaning that more stimulation was needed we take note that the focus of the ECB now appears to be shifting from whether to implement more stimulus measures to when to begin withdrawing them.

Below we discuss in detail why we believe the ECB will find that the conditions are in place to start hiking next summer and outline what an exit strategy might look like.

Growth

Unless inflation is very high (as in July 2008) ECB policy tends to be driven by growth developments. In 1999 the ECB started hiking when PMI new orders were 59 and in 2005 it hiked when they reached 54. PMI new orders are currently at 49.5 and increasing strongly. We anticipate that they could reach 59, or more, in early 2010 and would thus send a strong signal for the ECB to embark on a hiking cycle.

The ECB will have to revise its downbeat staff macroeconomic projections significantly up at the next Governing Council meeting. The ECB currently (June 2009) projects growth to remain negative until mid-2010, but with France and Germany out of recession in Q2 this year and the euro area in positive growth territory in Q3 – a year before the ECB officially expects – it will clearly have to change its view radically. We anticipate strong growth of about 3% q/q annualised in Q3 and Q4 09, driven primarily by the inventory cycle and exports. Thereafter we expect that growth will slow down to around 2% q/q in 2010 and become more broad based.