10 April 2006

EZA 733 Briefing note: ECB Observer

ECB Council Post-Meeting Assessment – April 06

As expected, ECB leaves interest rates unchanged; interest rates still 'very low' and monetary policy 'accommodative', but now in a 'process of normalisation'. Strong signals from Trichet that no rate change in May but highly likely in June, on the back of 'flash' Q1 GDP data and new macro projections, even though meeting in Madrid. GDP now seen as growing at around potential, with short-term risks 'balanced' but downside risks from Global imbalances and possible oil price hikes further ahead. Inflation set to stay above 2%, with continuing oil-price pass-through and impacts from indirect taxes and administered prices in 2006 and 2007, while upside risks remain. Continuing strong money/credit growth, stimulated by low interest rates, and 'ample' liquidity' still pointing to upside inflation risks also over medium/longer term.

EZA Conclusion: As EZA suggested before this meeting, Q1 GDP data and Eurosystem/ECB staff forecasts available to the June meeting could help persuade Governing Council doubters that the recovery was really on track. The expected 25 bp move in June, to 2.75%, however is far from sufficient to complete the process of 'normalisation'. With inflation and upside risks unabating over the shorter term and a still mounting medium- to longer-term threat from monetary developments as economic activity strengthens, the balance of argument has shifted further away from the downside risks to growth, reinforcing the hand of the more activist members of the Governing Council. This reinforces EZA in its view that there will be an additional 25 bp increase in rates, to 3%, and further increases to a broadly 'neutral' 3 3/4% - 4% in the course of 2007. To this we would add the caveat that neither the ECB's Executive Board nor its Governing Council see themselves as pre-committing to the achievement of a particular level of interest rates by a specified date. The timing and scale of any move will continue to be determined only by their pragmatic assessment of all the available, past and current, economic and monetary data.

© Graham Bishop