09 October 2006

EZA 761 Report: ECB Observer

ECB Council Post-Meeting Assessment (5 October 2006).

·As predicted by EZA, ECB raised 'refi' rate by 25 bp, to 3 1/4%, on 5 October.

·Trichet indicates no change on 5 November, current policy stance being to 'monitor very closely all developments' rather than 'strong vigilance', but 25 bp rise in 'refi' rate likely in December: refuses to correct market view that 'refi' rate in December will be 3 1/2%.

·If ECB's base scenario continues to be confirmed, 'a progressive withdrawal of monetary accommodation will remain warranted' but Trichet substitutes 'continue to monitor very closely all developments' in place of 'strong vigilance'.

·Real GDP growth proving stronger than expected and inflation persisting on average above 2% at least during 2007 before declining below 2% some time in 2008.

·Renewed acceleration of M3 growth and continuing rapid private sector credit and liquidity expansion, together with robust GDP growth and labour market tightening, point to increasing upside risks to price stability over the medium term.

·EZA sees ECB 'refi' rate hitting 3 3/4% in 2007 Q1 and, in contrast to markets who see ceiling max 3 3/4%, quite likely set to rise to mildly restrictive 4 1/4%-4 1/2% by end-2007.

EZA Conclusion: Trichet has given a fairly clear indication that the Governing Council is not going to raise rates again on 5 November but that a further 25 bp increase in the 'refi' rate, to 3 1/2%, is likely in December'. He refused to be drawn on rate prospects in 2007, but reading between the lines of his analysis of future prospects of continuing economic growth above potential and inflation stuck above 2% for the next 12-18 months, we maintain our view that the balance of concerns continues to edge towards upside inflation risks and away from downside growth risks and, contrary to financial markets expectations that rates will plateau, at the most, at 3 3/4% we are likely to see the 'refi' rate at a (mildly restrictive) 4 1/4%-4 1/2% before the end of 2007, as long as the growth and inflation forecasts of the ECB and most other forecasters continue to be validated.

© Graham Bishop