24 November 2005

EZA 712: Briefing Note: ECB Observer

Inter-Meeting Up-Date, November 2005
Trichet clearly signals that policy tightening is imminent. Little in the new data since 3 November meeting to explain this sudden change. 'Flash' GDP growth figure of 0.6% for Q3 and early sight of new staff macro projections, and possibly of October money numbers, at mid-month Governing Council meeting likely to have helped swing the debate. Argument likely to be: with 'headline' inflation set to continue high, money/credit growth out of control and economic recovery now materialising, inflation risks will go on mounting, so stop crying wolf and act before these crystallise. EZA sees a one-off 50 bp rise on 1 December more consistent with ECB's past practice and current concerns than a token 25 bp now followed shortly by 25 bp more. After so much strong talk about the inflation risks and the historically low level of present interest rates, a 25 bp rise at this juncture would be seen, in our view, as a sign of weakness and that further increases would be bound to follow. A 50 bp increase, however, would be fully consistent with Trichet's statement that he thought the ECB was ready to moderately augment rates (not modestly) in order to withdraw some of the accommodation while remaining accommodative and also his remark that he was not envisaging a series of rate rises. A 2.5% refi rate would still be well below a 'neutral' rate of around 3.5% Nevertheless, it can not be ruled that, in order to reach a full consensus on a rate rise now rather than later, a compromise will be reached on 25 bp, followed by a further period of 'wait and see'. In our judgement, a 50 bp rise next Thursday, with nothing further until March or even June, is the most likely outcome. A 25 bp rise, while still possible, would be a sign that the Governing Council knew that they would have to re-open the debate again soon, while to delay any decision until after the Christmas season seems now to be most improbable.

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© Graham Bishop