Four problems facing the ECB

This week the ECB will meet for the first time since it announced fresh accommodative measures on 5th June including cutting the deposit rate to negative and offering more cheap funds to banks to lend to the wider economy. While the market expects the ECB to remain on hold this week, the economic signals are screaming for more action. Below are four things we think that ECB President Draghi will need to address at Thursday’s post-decision press conference:

1, Inflation – price data for April showed headline prices stayed at 0.5% in June, this is one of the lowest readings since 2009. Although it is too early to assess the impact of the ECB’s recent actions on inflation, the fact that prices have been below 1% since September last year is still a major cause for concern. Although prices in Germany have picked up a notch, they are still only half of the ECB’s 2% target rate. Things across the periphery are even worse, in Italy, the third largest economy in the currency bloc; prices fell to 0.2% from 0.4% in June, and the lowest level since September 2009. The battle against deflation is far from over, and Draghi may have to keep the door open to further action at this week’s ECB press conference, to scare off the threat of deflation.

2, Lending: the latest money supply data from the currency bloc showed that private sector loans fell 2% on an annualised basis in May, down from -1.8% in April. The ECB will be hoping that their package of fresh LTRO funds can boost this number; however this data reinforces the uphill battle the Bank has to encourage demand for loans. Credit growth to the private sector has been contracting since April 2012, so the Bank may need more aggressive action down the line if it wants to bring this back into positive territory.

3, France: The second largest economy in the currency bloc is becoming a big problem, and it could make it on to the ECB’s agenda later this week. Its PMI data is lagging the periphery and earlier on Monday its statistics agency published its debt to GDP ratio for Q1, which rose to 93.4%, a record high. A country’s debt is considered a major problem if it gets above 100% of GDP, and if French debt accumulation carries on at its current pace, then we may reach 100% in the next 12 months. It appears that President Hollande’s 75% top rate of tax has had no impact on French debt levels, and today’s data may trigger more explicit wording in the ECB’s statement to get governments to do more to reduce debt loads. If the ECB sounds concerned about France then we could see the market panic.

It is also worth noting that as French debt-to-GDP has continued to jump, the opposite is true in Germany where the rate has fallen from a peak of 83.4% of GDP in 2010, to 79.9% in Q1 this year. Watch out for signs that Germany is getting annoyed with France’s inability to keep its borrowing under control. A spat between the two largest economies in the currency bloc could dent investor confidence and weigh on euro-based assets.

4, The EUR: Last but not least, the single currency hasn’t played ball since the last ECB meeting. It has risen for two consecutive weeks and is close to the high before the ECB meeting on 5th June at 1.3665. If Draghi and co. want to limit further upside for the single currency, and protect the recovery, it may need to keep the door open on Thursday to further policy action in the future.

The technical picture is fairly neutral for EURUSD. If it can break above 1.3670-80, the high from early June and also the 200-day sma, this would be a bullish development that could take us back to 1.3800 in the medium-term, however, the ECB may be hoping that it does not break this level, which could open the way to another leg lower.