Investors wait for Europe to follow US lead

Financial Times, February 3 2008
US interest rates cuts over the past two weeks have fuelled hopes that UK and eurozone policymakers will follow the lead of the Federal Reserve in loosening monetary policy decisively.On Thursday, the Bank of England is expected to cut rates by a quarter-point to 5.25 per cent, but the European Central Bank is likely to keep monetary policy unchanged after eurozone inflation rose to 3.2 per cent in January.

Beyond February, money markets are pricing in a further reduction in UK rates to 4.5 per cent and in eurozone rates to 3.5 per cent by the end of the year. However, this week’s data releases could raise some doubts as to whether these assumptions are overly aggressive.

The Fed’s action clearly signals that the risks of a US recession have increased markedly and ECB policymakers know European growth will slow this year.

Purchasing managers’ surveys of service-sector activity show a clear loss of momentum over the past 12 months, accompanied by rising inflationary pressures. These themes are expected to be present in January’s surveys, due tomorrow.

The headline measure of the UK’s PMI survey is expected to fall from 52.4 in December to 52 in January. The surveys suggest service-sector activity is expanding at its weakest rate in almost five years, consistent with annualised growth of about 2.5 per cent. Confidence among UK service-sector companies appears to be at its lowest ebb since the attacks on the World Trade Centre in September 2001 but further upward pressure in input and output prices could increase uncertainty among policymakers about how far rates can be cut.

UK manufacturing output for December, due on Thursday, is expected to show year-on-year growth wedge up from 0.1 per cent in November to 0.3 per cent. Manufacturers are likely to benefit from the depreciation in sterling but this will be offset by slower global growth and tighter credit conditions.

The headline eurozone PMI has fallen for the past three months to 52, suggesting GDP growth has dropped below trend. The ECB’s inflation concerns suggest a far clearer deterioration in the growth environment is required for a change in eurozone monetary policy.

Wednesday brings German factory orders for December, with year-on-year growth expected to slow from 16.6 per cent in November to 11.1 per cent. German industrial production for December, due on Friday, is forecast to increase from 3.5 per cent year-on-year to 4.1 per cent.

In the US, momentum in the service-sector is also waning, with the headline measure of the Institute of Supply Management non-manufacturing survey forecast to fall from 54.4 in December to 53.

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