A poll of thirteen economists at 13 banks suggests that the European Central Bank (ECB) will keep its reference rate low in the next six months. Faced with worries over debt woes across the periphery of the 16-nation euro zone, the ECB left its key financing rate unchanged at 1% February 4, suggesting that Europe’s economic recovery remains fragile and is still in need of accommodative policies.

The poll was conducted before the ECB held its meeting February 4 and amid concern that European governments will struggle to fund deficits. ECB officials have noted that it is crucial for the Greek government to reduce the budget deficit from 12.7% of the country’s GDP in 2009 to under 3% in 2012. Despite the ECB’s acceptance of the Greek government’s austerity plan, markets remain unconvinced and are increasingly coming to the view that Ireland, Portugal and Spain, in particular, will face mounting difficulties dealing with their own budgetary difficulties. In part because of the debt difficulties afflicting some of the eurozone’s countries, the economists in our poll anticipate a slight widening of European sovereign spreads. The median forecast for 10-year eurozone bond yields at the end of April is 3.48% compared to 3.38% in our last survey. Investors are already demanding bigger premiums to hold the debt of these countries, driving the cost (and yields) of insuring their debt to new highs.
The ECB has responded by saying that it will not make any commitments towards European countries which struggle to bring their public finances under control. Yet even without a bailout, the euro has come under pressure in recent weeks on expectations that European benchmark rates will remain lower for a longer period of time than the federal funds rate in the US. This outlook received a further boost February 5 when the US unemployment rate in January unexpectedly declined to 9%, the lowest level since August 2009. Fears over EU debt and a relatively stronger US economy, propelled the dollar to an eight-month high against the euro. Our poll now indicates the average euro/dollar rate at 1.48 in three months. This compares to an average forecast of 1.53 in our last poll while the actual spot rate stood at 1.39 on February 5. Greece’s financial woes have contributed to euro weakness. “In view of the crisis, sovereign risk has become a significant factor for exchange rates,” notes HSBC. However, three of our panellists (JP Morgan, Citigroup and Goldman Sachs) have not changed their euro/dollar projections and anticipate a renewed pull-back in the value of the dollar.

Consensus February 2010

H.C. and V.B.