28 November 2005

EZA 713: Briefing Note: ECB Observer

ECB 1 December Council Preview
RATE RISE CLEARLY INDICATED FOR THURSDAY, WITH ONE-OFF 50 bp SIGNAL MORE SUITED TO ECB's WORRIES THAN 1 OR MORE 25 bp MOVES Rate rise on 1 December clearly signalled by Trichet. Main causes of ECB concern are persistent inflation above 2%, continuing strong monetary growth, negative real interest rates and signs of rising inflation expectations (though these are now receding). Markets expect 25 bp hike in December, further 25 bp in February/March. EZA sees 25 bp too timid a signal, given strength of ECB's concerns: we expect a one-off 50 bp rise on Thursday, but 25 bp a possible compromise. With little in latest economic data to warrant immediate action, we expect ECB to emphasise need to pre-empt materialisation of inflation risks. Our reading of Trichet's remarks, together with our analysis of the economic data (see attached), thus still leads us to conclude, as in our recent inter-meeting up-date (EZA712/24Nov05), that only a 50 bp rise - as a clear one-off signal - would be fully consistent with the ECB's current concerns. A 25 bp rise would not be sufficient to address these adequately and at least one more, if not two, 25 bp rises would then be needed. Even so, it is possible that not all of the 18 members of the Governing Council are yet persuaded that a 50 bp move is needed now and that some might still argue for a smaller move or a slight delay. If this were the case, a 25 bp rise might emerge on Thursday as a compromise in order to reach a consensus. EZA concludes, therefore, that the odds on a 50 bp hike now are around 70%, with 25% on a 25bp rise and 5% on a delay to January.

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© Graham Bishop