FRANKFURT (MNI) – The latest data suggest the expected slowdown of
the Eurozone’s recovery has already begun, but European Central Bank
Governing Council members remain unconcerned about near-term growth
prospects.

Governing Council member Quy Quaden said Wednesday that the ECB
would continue its exit from non-standard measures next year, but
increasing financial market tensions are a giant question mark hovering
over the speed of this exit.

German industrial production in July fell significantly short of
analysts’ expectations (+0.1% vs +1.2%), the German economics ministry
reported Wednesday. The news comes on the heels of Tuesday’s report of
an unexpected 2.2% July drop in demand for German manufacturing goods.

Foreign trade data for Germany and France, also released Wednesday,
show a significant slowdown in trading volume, possibly reflecting the
impact of cooling global growth. While France’s import and export growth
decelerated sharply, Germany’s fell into negative territory.

Meanwhile, the Bank of France warned that the country’s economic
recovery is likely to lose a little steam in 3Q, as activity stagnated
in industry and services in August.

Although data suggest the Eurozone’s recovery is cooling off,
Council members did not sound any warning about near-term growth
prospects.

Axel Weber noted that “the real economy is developing much better
than expected at the start of the year.” He said that he does not share
fears of a double dip recession or a deflation but instead expects
“moderate growth and price stability,” at least over the monetary policy
relevant horizon.

Similarly, Quaden projected “relatively low growth…without a
relapse into recession.” While there should not be euphoria on the
recovery, some optimism is warranted, he said.

Nevertheless, on Tuesday Executive Board member Juergen Stark
warned of downside risks beyond 2010. “We are pleased with the recent
economic developments, however we have also said that we see certain
risks for the economic outlook beyond this year,” the ECB’s chief
economist said.

Given the growth and inflation outlook, the ECB’s current loose
monetary policy stance remains the right one, Stark asserted. “The
policy is accommodative, but also appropriate,” he said.

Despite this, the withdrawal of non-standard measurers should be
continued next year, Quaden said in an interview with Belgian daily
L’Echo published Wednesday.

“The unconventional measures are by definition temporary. We have
started to dismantle them carefully. It is preferable and likely that
this process continue next year,” Quaden said. “The banking industry can
not depend on the exceptional credit of the ECB forever.”

Quaden said that last week’s decision to keep supplying unlimited
liquidity at 1-week, 1-month and 3-month maturities was motivated by end
of year liquidity tensions and the expiry of two longer-term money
market operations in the fourth quarter, suggesting that he might favor
further exit measures after the Council’s monetary policy meeting in
January.

However, last Thursday President Jean-Claude Trichet explicitly
denied that the two factors cited by Quaden had been the Council’s sole
motivation in maintaining full support, thus implying that worries about
the health of the banking system and its dependency on the ECB still
prevail.

And things might yet get worse, Weber warned earlier today. “Even
though financial markets have calmed again, they are still marked by
heightened uncertainties and are not immune to setbacks,” he said,
adding that the latest jitters about the health of Europe’s banks bear
witness to this uncertainty.

Concerns over the Irish banking system and doubts that the country
will be able to manage the cost of bailing it out sent Irish bond
spreads on Wednesday to their widest level since the start of European
Monetary Union. Sovereign debt spreads of other peripheral countries
followed Ireland’s trend.

Weber asserted that any concerns over a Eurozone country defaulting
were exaggerated. “The sum of measures initiated by governments, in
cooperation with the IMF, should be enough to end [market] discussions
of a potential state insolvency,” Weber said.

Wednesday’s downward revision of Greek GDP to -1.8% from -1.5%,
however, is unlikely to foster investor confidence that Greece can
emerge from the crisis on the strength of its own efforts.

According to market rumours, the ECB continued to buy Greek, Irish
and Portuguese bonds on Wednesday. An exit from the Securities Markets
Programme in the months ahead appears very unlikely. Weber, who had
vehemently opposed the program, conceded earlier today that it is
“certainly true” that some Eurozone countries will be dependent on
support within Europe for some time.

An exit from unconventional policies next year is no doubt on ECB’s
radar screen, but banking on big steps in early 2011 is premature.

–Frankfurt newsroom +49 69 72 01 42; Email: jtreeck@marketnews.com

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