16 January 2007

EZA 774 Briefing Paper: ECB Observer

ECB 11 January Council Post-Meeting Assessment

·As generally expected, ECB kept its key rates on hold this month but strong hints that next hike will come on 8 March, as predicted by EZA, and not 8 February.

·Trichet's statement very similar in tone to last month's: interest rates still 'low', policy still 'accommodative', 'very close monitoring is of the essence' and 'acting in a timely manner is warranted'.

·Trichet all but endorses market expectations of a rate rise this quarter but implies the move will come not in February but in March.

·ECB sees economic growth continuing solidly at around potential over the medium term and inflation hovering around 2% this year and next.

·Downside risks to growth again acknowledged but inflation still subject to upside risks, including danger of inflationary wage settlements.

·Continuing concern at rapid growth of M3 (re-accelerating in November) further acceleration of lending to companies and only slight easing up in growth of lending to households, against background of improved economic conditions and ample liquidity.

EZA Conclusion: Trichet has given a fairly clear indication that rates are set to rise by 25 bp in March, as EZA has been predicting. The ECB's view of the outlook for growth (at around trend) and inflation (hovering around 2%, ie at or slightly above the ECB's definition of price stability) this year and next, together with tightening labour market conditions and the failure of rate increases so far to make a dent in monetary and credit growth, in our view points to further increases - to 4 1/4%/4 1/2% by end-2007 - still to come. Markets, in contrast, appear to see a ceiling of 4% being reached around mid-year.

© Graham Bishop