The EU reported that Q3 GDP rose 0.4%. A 0.5% rise was expected by the consensus of economists. The GDP rise confirms that EU is slowly emerging from recession. As the EU economy emerges from recession the ECB is expected to begin its plans for an exit strategy from monetary stimulus. Monday, the ECB's Weber said that the EU must begin preparations for an exit from extraordinary fiscal and monetary measures. The withdrawal of stimulus will be gradual because of uncertainty as to whether the EU recovery sustainable. A breakdown of Q3 GDP shows that most of the improvement was due to an increase in exports. If the EUR continues to rally and the global recovery slows the EU export led recovery may be at risk. The EUR continued to rally in Monday's trade. EUR was supported by China's rejection of calls for Yuan revaluation and a surge to new high for 2009 in US equities as APEC joins the Fed and G-20 pledge to maintain fiscal and monetary stimulus.
Sunday, China rejected the US and international call for Yuan revaluation. The fact that China is not ready to allow the Yuan to strengthen may mean global rebalancing will increase selling pressure for the USD and upward pressure on the EUR. Last week the Fed reaffirmed its commitment to maintaining low yields, the G-20 said it will continue to support monetary and fiscal stimulus and over the weekend APEC said it would maintain its commitment to fiscal and monetary stimulus until the global recovery is secured. Global growth and the recovery are highly dependent upon monetary and fiscal stimulus. As long as these policies continue the USD remains vulnerable and the EUR should remain firm. Continuing EUR strength may choke off the EU export led recovery.
Strong EUR is not only a treat to EU exports but contributes to weaker EU inflation. EUR inflation declined for the 5th month in a row in October falling 0.1% y/y. EU inflation is expected to turn positive in the coming months but remain a below target through 2011. ECB mandate is price stability. ECB President Trichet said that unconventional policy measures that do not threaten price stability will be allowed to continue. This means that the ECB may elect to continue 3 and six month auction until the addition of liquidity boosts inflation. An additional risk to the sustainability of the EU recovery is rising EU unemployment. EU September unemployment rose to it highest since January of 1999 at 9.7%. Rising unemployment will limit the recovery in consumer demand and may encourage the ECB to continue with it covered bond purchases into Q1 2010.
The next ECB policy meeting will be held in early December. We expect the ECB to lay out the details of its exit plan at the December policy meeting. The ECB will likely let its emergency liquidity measures expire naturally and maintain steady monetary policy. Because of uncertainty about the sustainability of the EU recovery, continued high unemployment and falling inflation the ECB is unlikely to be in any hurry to hike interest rates and tighten monetary policy. The ECB's monthly bulletin says that ECB expects EU GDP to grow by 1% 2010. This GDP growth forecast may be at risk if the ECB begins withdrawing stimulus too soon. The ECB's exit from emergency liquidity measures will be a separate decision from timing of the ECB's decision to hike interest rates. An ECB rate hike is not expected until mid 2010 at the earliest. The exit from fiscal stimulus will take longer. The EU commission calls on Europe to ready its fiscal exit strategy before 2011.Note in the graph below that despite improvement in EU Q3 GDP EU annual GDP declined by 4.1%. The ECB must be careful to not remove stimulus too quickly and put the fragile EU recovery at risk. The ECB exit plan is coming next but a quick exit by the ECB is unlikely.