06 July 2005

EZA 684: ECB Council Post-Meeting Assessment, June 2005

ECB Post-Meeting Assessment; central expectation remains rates on hold even well into H1 2006
SPECULATION OF RATE CUT MISGUIDED - EZA CENTRAL SCENARIO REMAINS RATES LIKELY ON HOLDTHROUGH SPRING/EARLY SUMMER 2006 ECB's assessment remains broadly in balance, with recognition of present weakness of real growth but continuing expectation of recovery in coming months and slight tilt towards inflation risks over medium term. Press talk of possible rate cut ahead misguided. Trichet points to exceptionally low interest rates across spectrum providing considerable support to growth. Sees moving rates up or down now as counter-productive, but ECB would act if needed to guars against inflation. ECB determined to maintain confidence in price stability in wake of referendum results; dismisses talk of EMU break-up as nonsense. Consumers/investors should consume/invest, trusting ECB to deliver price stability.

SummaryEZA Conclusion: Trichet's remarks again lend support to EZA's long-held contention that rates likely to remain on hold through to spring/early summer 2006. Rate cut not on the cards but low-probability political event risks or second-round inflation effects could induce earlier rate rise. EZA Comment: Press reactions to the effect that Trichet was leaving the door open for a rate cut are highly misleading. Of course the Governing Council always has open to it the option of lowering rates if deflation were looming but, as long as they expect economic activity to recover and demand pressures to start to emerge - especially given inflation risks from high oil prices, a weaker exchange rate, potential second-round effects and the liquidity overhang - their eyes will remain firmly on the prospective need to start raising rates back towards more normal levels. Indeed, while Trichet acknowledges here, even more clearly than a month ago, the recent and current weakness of demand, he remains confident that activity will strengthen and he now appears to be showing rather greater concern than last month about the inflation risks indicated by the monetary analysis. The overall assessment thus remains broadly in balance, with perhaps a slight tilt towards concern about inflation risks over the medium term. EZA therefore maintain, as their central case, that rates will remain on hold until late spring or early summer 2006, when evidence that economic growth is safely returning to trend might be mounting and so provide the justification for raising rates. Market jitters in response to the political confusion caused by the two referendum results, let alone calls by politicians for monetary easing, are not likely to sway the Governing Council from this course.

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© Graham Bishop