Risk of disappointment from the ECB in June remains high

The euro area recovery continues to be uneven. The economy is clearly expanding, but while growth accelerated in the service sector, it is slowing in manufacturing (based on Markit's Purchasing Managers Index report.) Some are blaming the slowdown in manufacturing on weakness in the export sector - driven by factors such as China and the strong euro.

Eurozone Markit PMI (source: Markit/Investing.com)

Moreover, growth has been uneven across the region, with France now shifting back into contraction mode.

Reuters: - An earlier PMI from Germany showed Europe's largest economy was again the driving force - its composite PMI held steady at 56.1. But it was a different story in France, the euro zone's second largest economy, where the composite PMI slumped back below the 50 mark after just two months in growth territory.

French Markit PMI - note that a reading below 50 indicates contraction (source: Markit/Investing.com)

As France slows, the Eurozone's ability to pull out of the current disinflationary mode will be limited.

WSJ: - ...with the French economy struggling to generate even modest growth, any pickup in the euro zone as a whole is unlikely to be strong enough to boost consumer prices and end a period of low inflation that stretches back to October.

However, the fact that the Markit report continues to show expansion in aggregate increases the risk that the ECB may stay on the sidelines in June. Alternatively the action could end up being limited in scope. That will certainly generate a sell-off across fixed income markets in the EU and even in the US. It's one of the reasons euro government bond yields have backed up in recent days (see chart).

Markit: - Deflationary pressures remain a major issue ... and the ongoing fall in average prices charged for goods and services adds to the likelihood of the ECB taking action to boost the economy at its June meeting. However, policymakers will also be minded of the steady recovery the region appears to be undergoing, suggesting that anyone expecting any aggressive policy initiatives may be disappointed.

In fact, Bundesbank is still ambivalent about the need for the ECB to act next month. The risk of a major "disappointment" in June remains high.

WSJ: - The jury is still out on whether the European Central Bank will need to take action at its next policy meeting in June, ECB governing council member Jens Weidmann said in an interview with the daily Sueddeutsche Zeitung.

"It's not clear if we even need to act," Mr. Weidmann was quoted as saying.

His remarks diverge somewhat from a message earlier this week offered by ECB executive board member Yves Mersch, who said the probability of action by the ECB has risen considerably.

SoberLook.com

From our sponsor: