Strong EU forecast -- Time to rebalance your portfolio?

May 13, 2006

The ECB decided not to raise prime lending rates at their May 4 meeting. President Trichet based their decision on the following factors:

• EU GDP growth in the first quarter was surprisingly strong, and is expected to continue to be strong in the second quarter.
• For the rest of the year, the global economy continues to look strong, providing support for EU exports.
• The greatest risk continues to come from oil price shocks, with trade protectionism also of great concern. Both will contribute to inflation in the form of higher prices.
• The third chronic risk is the high U.S. current account deficit, which is unsustainable. The dollar needs to decline slowly and carefully to avoid a disruptive impact.
• Inflation is also a chronic concern. The EU target is 2%, and rates have been hovering around 2.2% - 2.4% in the first quarter.
• There is ample liquidity in the financial sector, leading to a greater risk of bad investments and overcapacity.
• However, this liquidity is needed in the private consumption sector to support domestic spending.

What it Means:
Basically, it all means that the EU economy is healthy, but still a little slower than they would like. The biggest problem is that it is overly reliant on exports to the U.S. That is why the EU didn’t raise rates this month...they would like to give the economy a little more time to drive domestic demand. Over time, all countries know they need to shift away from exports to the U.S., and towards domestic demand.

Action Steps:
Talk with your financial planner to be sure you have a good amount of European mutual funds. These funds will not drive growth as much as the emerging market funds, but will provide a good diversification from an over reliance on U.S. funds. If you have been in emerging markets over the past two years, now might be a good time to take some profits off the table and shift some of your allocation into European funds.

Source: ECB Press Conference, May 4, 2006