12 February 2007

EZA 778 Briefing Paper: ECB Observer

ECB 8 February Council Post-Meeting Assessment

·As expected, ECB kept interest rates on hold this month but Trichet gave clear indications that the next increase would be on 8 March.

·ECB now 'strongly vigilant' rather than 'monitoring very closely', while monetary policy still described as 'accommodative' and, again, 'acting in a timely manner is warranted'.

·ECB sees economic expansion having continued into 2007 and medium-term outlook favourable, with risks to growth balanced in short term, on downside over longer term.

·Favourable base effects point to temporary slowing of inflation over next few months but further ahead risks still seen on upside, with stronger emphasis on wage risks and ECB expressing view that capacity utilisation nearing peak last reached in 2000.

·Together with accelerating monetary growth and still strong credit growth, this suggests ECB sees medium-term upside inflation risks as having intensified over the past month.

EZA Conclusion: Barring unexpected developments in economic data over the next four weeks or in the ECB Staff's spring macroeconomic projections, a 25 bp rise in the 'refi' rate to 3 3/4% on 8 March is virtually a done deal. The implied heightening of inflation risks over the past month reinforces EZA's long-held view that more tightening is still to come, with 4 1/4%-4 1/2% likely by end-2007, in contrast to the market view that the 'refi' rate will peak at 4% around mid-year. We even see an intensification of the ECB's tightening stance as possible if there were signs that inflationary wage settlements were beginning to emerge.

© Graham Bishop