10 July 2006

EZA 749 Report: ECB Observer

Council Post-Meeting Assessment, July 2006

·As widely expected, ECB leaves interest rates unchanged on 6 July but surprise announcement that Governing Council will meet physically, and not by teleconference, on 3 August, with press conference to follow.

·Trichet signals that 25 bp rise in 'refi' rate likely then, with 50 bp all but ruled out, and policy stance shifts from monitor all developments closely to exercise strong vigilance.

·Inflation expected to remain above 2% in second half of 2006 and on average in 2007 but upside risks to price stability remain.

·Continuing double-digit credit growth and further acceleration of M3 annual growth rate to 8.9% point to increased upside risks to price stability over medium term.

·Latest data seen as confirming ECB's assessment that economic growth has regained momentum and become more broadly based.

·Short-term risks to growth again 'broadly balanced' but, further ahead, downside risks from global imbalances, possible oil price hikes and protectionism still prevail.

EZA Conclusion: Trichet is unambiguously signalling that a further 25 bp rate rise, to 3%, is highly likely on 3 August, contingent on the ECB's economic and monetary assessment at that time, and that this should not be read as a decision by the Governing Council to accelerate the pace of policy tightening. With the balance of risks still firmly tilted towards the inflation side and likely to continue that way for some time, we maintain our central view that another 25 bp rise is likely by year-end, with a further 50 bp to come, in one or two steps, in the first half of 2007. This would bring the 'refi' rate to a 'neutral' 3 3/4% by next June, but we do not entirely rule out an extra 25 bp being squeezed in between now and then.

© Graham Bishop