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Euro Week Ahead: ECB Meeting In Focus As Recovery Stalls

LONDON (MNI) - European investors, rocked by some of the steepest equity market declines of the year, will look to the European Central Bank for direction in the week ahead as political risks in Russia and a stalling recovery at home raise even more questions over the Bank's policy approach.

Concern has been heightened, as well, with the slippage of currency area inflation to 0.4% last month - the lowest since the depths of the global financial crisis in October 2009. With negative inflation rates reported in Spain and Greece, and slower-than-expected readings from Italy and Germany, investors are again questioning the ECB's conviction with respect to a full blow deflationary threat in the Eurozone.

The broader economic recovery, at the same time, is doing little to assuage those concerns: German business sentiment has fallen for three consecutive and manufacturing activity around the Eurozone it little changed from modest levels it reached in November of last year (Markit Economics said the gauge hit 51.8 in July, unchanged from June and below the MNI median forecast of 51.9).

Against that backdrop, investors will take their cues from the final reading of activity in the services sectors of Europe's biggest economies Tuesday, in the form of PMI data from Markit, and the first estimate of second quarter GDP growth from Italy.

The latter is likely to provide an interesting contrast to the better-than-expected 0.6% advance reported by Spain last week - a pace that's likely to lead the whole of the currency area in the three months ending in June. Italy, Europe's third largest economy (but its largest bond market) shrank by -0.1% in the first quarter of this year and will have to provide something of a later-hour surprise to avoid slipping back into its fourth recession of the last 10 years when it reports preliminary figures on Wednesday.

Another key data release for the week comes early Thursday, when Germany's statistics office updates on manufacturing output in Europe's biggest economy for the month of June. Following contracts that were larger than expected in April and May, the June reading will go some way towards indicating whether Germany can maintain its overall growth rate in the second quarter or slip back closer to mean pace of the rest of the Eurozone. If so, the consequences for the August 14 estimate of euro area GDP will be of paramount importance.

Just how - or if - all of this will be acknowledged by ECB President Mario Draghi and his Governing Council colleagues when they meet Thursday in Frankfurt for their final rate decision of the year remains to be seen. However, it's clear from both public comments and private briefings with MNI that there is little anticipation of any policy changes this month, but rather a broader explanation of how the ECB may react if deflationary pressures become real and medium term inflation expectations become dis-anchored.

Most analysts, however, assume the Bank's September meeting will have more significance, especially given the fact that the Bank will publish updates estimates for growth and inflation in its quarterly Staff Forecasts.

That's not to say Draghi won't face testing questions with respect to both the European Union's decision to apply sweeping economic sanctions on Russia and the growing concern that European Commission President Designate Jean-Claude Junker will take a more relaxed view towards the currency area's hard-won fiscal rules when he forms his new Commission in September. He is also very likely to take questions on the financial crisis that's currently engulfing Portugal's second-biggest bank, Espirito Santo, and the fact that it's been ordered to raise billions in new capital at the same time its meant to be undergoing a rigorous Asset Quality Review and stress test run by the ECB itself under its pending authority as the region's single banking supervisor, which it assumes in November.

Owing to the ECB meeting, which begins with the traditional monthly dinner in Frankfurt Wednesday evening, there are no scheduled policy speeches from any of the Bank's Executive Board.

By Martin Baccardax.

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