Investment Research — General Market Conditions

04 August 2010

Flash Comment
ECB preview: ECB likely to be pleased
Overall we expect this month’s meeting in the ECB Governing Council to be a non-
Euro area growth close to peaking
event and we thus do not look for any major market movements.
70 70
Index, PMI France, Service sector
65 65
We expect the ECB to keep its refi rate unchanged at 1.0% and do not expect it to 60
Germany, manufacturing sector
60
55 55
announce any new liquidity or other emergency measures. 50 50
45 EMU, manufacturing, 45
The ECB can take comfort in the latest market developments and economic news 40 New export orders 40
35 35
flow, which have been mainly positive. The debt crisis has faded, but there are still 30 30
08 09 10
risks.
Source: Reuters Ecowin
The key risk would be that the ECB tightens its rhetoric, which could lead to higher
money market rates and thus steepen the EONIA curve further.

We expect a first interest rate hike from the ECB in H2 2011. Current market pricing, Inflation has also peaked
based on EONIA forwards, suggests a first hike around mid-2012. 4.0
% y/y % y/y 4.0
Euro area inflation,
3.0 3.0
including Danske Bank forecast
2.0 2.0
Latest news flow has mainly been positive 1.0 1.0

0.0 0.0

-1.0 -1.0
Better economic data 08 09 10 11

The latest data suggest that economic activity was robust during Q2, and that the strong
Source: Reuters Ecowin
momentum was maintained entering Q3. Especially the German manufacturing and
French service sectors are expanding briskly. Consequently, euro area growth is likely to
be stronger than anticipated by most watchers – albeit at an uneven pace. Meanwhile, US ECB purchases have declined
and Asian economic data have deteriorated, which should keep optimism in check. The 130
EUR bn
22.5
EUR bn ECB purchases,
latest PMI surveys indicate that export growth has probably peaked and we expect per week >>
110 17.5

economic momentum to decline towards year-end. Furthermore, the positive boost from a 90 << Asset purchases 12.5
(covered+govies)
weaker EUR has recently been somewhat reversed by the recent upward movement in 70 7.5

EUR/USD. Inflation rose to 1.7% in July, but mainly driven by base effects stemming 50 2.5

from food and energy prices. There is limited inflationary pressure in the euro area, and 30 -2.5
w9 w11 w13 w15 w17 w19 w21 w23 w25 w27 w29
10
this is unlikely to change in the foreseeable future. We expect inflation to average around
Source: Reuters Ecowin
1.5% over the next year. Inflation expectations remain firmly anchored.

Securities Market Programme (SMP) and bank stress tests: PIIGS tighten – except Greece

The ECB has scaled down its government bond purchases to close to zero and
government bond spreads in periphery markets (PIIGS) have tightened significantly over
the past couple of weeks. In total ECB has bought government debt worth around
EUR60bn through the SMP, but currently the need for further purchases seems to have
abated. The release of the bank stress tests, on 23 July, seems to have had a positive effect
on the sentiment.
Source: Reuters Ecowin

Senior Analyst
Lars Tranberg Rasmussen
+45 45 12 85 34
laras@danskebank.dk

www.danskeresearch.com
Flash Comment

Banks report tighter credit standards

Banks tighten credit standards in Q2
The quarterly bank lending survey was released last week and the clear impression is
80 Net bal 80
Net bal
that credit standards are still tightened, both for loans to enterprises and households. A Credit standards
60 60
key reason for this is mentioned to be renewed constraints in banks’ access to funding and
40 40
House
liquidity management. The latest report on monetary developments also indicates that purchases
20 20
Tightening Consumer
bank credit expansion remained subdued in June, due to both supply-side and demand- 0 credit 0
Enterprises
side factors, although there were some increases in the monthly flow of loans to non- -20 -20
financial corporation and households. The improvement in the M3 growth from -0.1% y/y 05 06 07 08 09 10

in May to 0.2% y/y in June can mainly be attributed to a deceleration of deposits being
Source: ECB
moved into bank liabilities outside the M3 definition. Overall the signals from the banks
should keep the ECB rhetoric in check. It might be that most banks passed the stress-tests,
but the financial sector is still struggling with balance sheet restructuring and weak loan
EONIA fixing declining
demand.
0.75 0.75
% EONIA
Money market remains volatile 0.65
6M
0.65
3M
Excess liquidity in the euro system money markets was reduced significantly from around 0.55 0.55
1W
EUR300bn to around EUR100bn as the one-year long-term refinancing operation 0.45 0.45
Fixing
(LTRO) expired on 1 July. This led to increased volatility in money market rates and 0.35 0.35

EONIA fixings temporarily increased significantly. In recent weeks, however, EONIA 0.25 0.25
Feb Mar Apr May Jun Jul Aug
fixings have declined significantly on the back of excess reserves that have been built up. 10

Next Tuesday the current reserve maintenance periods ends, which reduces demand for Source: ECB
liquidity and supports lower EONIA fixings. However, with less excess liquidity in the
system more focus will be on weekly main refinancing operations (MRO). This week’s
ECB MRO amounted to a net liquidity reduction of EUR35bn. As the amounts allotted in
the weekly MROs have become more volatile with less excess liquidity in the system, But EONIA curve has steepened
uncertainties regarding the overall liquidity situation have increased, which justifies a 30 Bp 6M minus fixing 30
Bp
20 20
liquidity premium that is reflected in the steeper EONIA curve. Going forward, we expect
10 10
the EONIA curve to remain steep at least until the amounts allotted in the weekly tenders 0 0
(MRO) become more stable. -10 -10
-20 -20
3M minus fixing
-30 -30

Market reaction expected to be limited Jan Feb Mar Apr

10
May Jun Jul

We expect this month’s meeting in the ECB Governing Council to be close to a non-event Source: ECB
and we only expect limited market impact. If anything, the risk would be that the ECB
tightens its rhetoric, which could lead to higher money market rates and thus steepen the
EONIA curve further, as it would imply a greater likelihood of the ECB continuing its
exit strategy during Q4. If this materialises, it should lift EUR/USD.

No hikes are priced before mid-2012 Euribor has increased EUR/USD has moved higher recently
5.0 % 5.0 0.9 % 0.9 1.55 1.55
1M Eonia (including forward) % %
0.8 0.8 1.50 1.50
4.0 4.0 3 month Euribor 1.45 1.45
0.7 0.7 EUR/USD
3.0 3.0 1.40 1.40
0.6 0.6 1.35 1.35
2.0 2.0 1.30 1.30
0.5 0.5
ECB refi rate 1 week Euribor 1.25 1.25
1.0 1.0 0.4 0.4
(including DB forecast) 1.20 1.20
0.0 0.0 0.3 0.3 1.15 1.15
00 02 04 06 08 10 12 Jan Feb Mar Apr May Jun Jul Jan Apr Jul Oct Jan Apr Jul
10 09 10

Source: Reuters Ecowin and Danske Bank Source: Reuters Ecowin Source: Reuters Ecowin

2| 04 August 2010
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Flash Comment

Disclosure
This research report has been prepared by Danske Research, which is part of Danske Markets, a division of
Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The authors of
this research report are Frank Øland Hansen, Senior Economist and Lars Tranberg Rasmussen, Senior Analyst.

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