Scylla, Charybdis & the Horse Latitudes

Scylla & Charybdis were two sea monsters living on opposite sides of the Strait of Messina posing a very serious threat to passing sailors of the day. Avoiding one typically meant taking great risk passing too closely to the other. The phrase, believed to be the progenitor of the phrase ‘between a rock and a hard place’ is where the European Central Bank finds itself today; presiding over increasingly weak economic data and stubbornly high inflation readings.

Unlike the Fed whose psyche bears the scars of the Great Depression (and thus likely to risk inflation in favour of growth) the ECB remains eternally cognisant of the hyper inflationary years of the Weimar Republic. The ECB yesterday left its benchmark re-financing rate, as expected, at 4% and continue to focus, as per their mandate on the “upside risk to price stability.” However recent economic data has suggested the economy has begun to cool. Manufacturing ex-Germany continues to slow, whilst exports continue to be hampered by the strength of the Euro. The housing correction underway in countries like Spain, Italy & Ireland is undermining consumer confidence and consumption is hampered by real disposable income hits from surging energy and food prices.

Ultimately slower European and global growth should lead to lower European inflationary expectations enabling the ECB to respond with interest rate cuts, though perhaps not for some time yet. In fact if you go back a few years to 2003 you can find evidence of the ECB willing to cut rates despite inflation above its 2% comfort zone.

As an aside risk assets have been enjoying something of a renaissance since the Fed organised the bailout of Bear Stearns through JP Morgan in March. The Merrill Lynch European High Yield Constrained Index returned 5.31% during the month of April, recovering most of the losses it saw through the first quarter of the year. This week, however, feels somewhat range bound. In a report from earlier this week, Goldman Sachs used the analogy of the corporate bond markets heading for the ‘horse latitudes’- pretty apt I thought, once I’d looked it up!