No rate change seen Thursday, or even until end 2005/early 2006: Slight lessening of inflation worries, no SGP 'Retribution'
Slight lessening of inflation concerns: costs and prices still largely contained, demand remains in doldrums and modest easing of monetary worries EZA's central expectation remains: no rate increase (or cut) this week or even before very late 2005/early 2006, but ........ ECB's concern at weakening of Stability and Growth Pact (SGP) unlikely to prompt immediate punitive action. Slight lessening of inflation concerns: costs and prices still largely contained, demand remains in doldrums and modest easing of monetary worries Adverse market/government reactions to SGP revisions, Lisbon agenda prospects, French referendum, could trigger earlier and bigger rate rise
Summary
we see no grounds for the ECB to alter its monetary policy stance this month. Looking further ahead, we see no grounds either, at present, to alter our central view that interest rates will stay on hold for several more quarters until, perhaps in the fourth quarter of this year or even the early part of 2006, there is sufficient evidence that growth has returned to trend, at an annual rate of around 1 3/4%-2%.
In this longer view, we continue to differ from many market analysts, who seem to be swayed unduly by shorter-term perspectives rather than the medium-term outlook on which the ECB focuses. A number of market commentators are now suggesting that what they see as a weakening of the SGP will induce the ECB to bring forward the expected rise in interest rates by a month or two. To the extent that market operators listen to their analysts, this appears to be reflected in the Euribor futures market, which at the end of March was pricing in a 25 basis point rise in September and a further 25 bp rise by January-February, compared with the 25 bp rises in October and March foreseen a month ago:
We do now, however, introduce a new set of caveats. If the revisions to the Stability and Growth Pact were to lead governments to start to flaunt the rules more brazenly or extensively, or if financial markets (including the foreign exchange market) were to factor in the possibility that governments might do so, and/or if financial markets were to take fright at a 'petit Non!' in the French referendum on the Constitutional Treaty, these developments - taken together with the seemingly weak commitment of Member States to the Lisbon process, might generate additional, second-round market fears that the EU and EMU project was starting to unravel.
If these factors were to come into play and strike at the exchange rate and inflation, we believe the ECB would feel obliged to raise interest rates quickly and substantially. This we see as the significance in the words of the ECB's press statement, that the Governing Council 'remains committed to deliver on its mandate to remain price stability' - regardless of the political consequences of any short-term impact on growth.
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© Graham Bishop
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