ECB may cut rates to 0.5% mid-year
Largely due to additional fiscal tightening measures (mainly in Italy and Spain), Citi analysts are cutting their GDP forecast for the euro area to -1.5% for 2012 and -0.4% for 2013. After the downgrade of several euro area nations' sovereign ratings, the European Financial Stability Facility's (EFSF) functioning is likely to suffer and the planned introduction of the European Stability Mechanism (ESM) looks ambitious for the most part.
The European Central Bank (ECB) has announced that it will widen the collateral pool further to pave the way for substantial use of the second 3-year long term refinancing option (LTRO) in February. In addition, Citi analysts expect that the ECB will take further action to widen the collateral pool to ease banks' funding problems. On rates, Citi analysts anticipate the ECB to cut the main refinancing rate from 1.0% to 0.5% in the second quarter of 2012 to reduce the deposit rate to 0.1% and to reduce the rate for marginal lending facility to 1.25%.
Given the widening macro dispersion between Europe vs. US and Emerging Markets (EM), Citi analysts believe that stocks with international exposure should help deliver better earnings growth and a lower risk profile than European-focussed stocks.
Indeed, gradual improvements in the labour and housing market, combined with reviving auto production and signs of increased competitiveness signal that the US is doing better. By itself, a US GDP growth forecast of 2% is fairly subdued. But the US and Euro Area GDP growth differential is reaching around 3.5%-4%, a level not seen in recent decades. The gap is even wider when comparing Euro Area with Emerging Market (EM) GDP growth expectations. An EM and Euro Area GDP growth differential of 6.5%-7% for 2012 is the widest level seen since the onset of the financial crisis. In a world that has not enough growth and too much debt, EM appears well placed with more growth than developed markets and less debt too.