12 March 2007

EZA 782 Report: ECB Observer

ECB 8 March Council Post-Meeting Assessment

·As previously signalled by Trichet, ECB raised key rates by 25 bp on 8 March.

·Interest rates now 'moderate' rather than 'low', policy 'on the accommodative side' rather than 'accommodative', while 'monitor very closely' returns in place of last month's 'strong vigilance' and 'acting in a timely manner remains essential' is retained.

·Staff projections revise growth up, with mid-point estimates of 2.5% and 2.4% in 2007 and 2008 respectively, and inflation down to 1.8% in 2007 and up slightly to 2.0% in 2008.

·Downside risks to growth remain over medium to longer term but inflation still subject to upside risks including, in particular, danger of inflationary wage settlements.

·Continuing concern at record M3 growth rates and still rapid growth of lending to private sector, especially to companies, given improved economic conditions and ample liquidity.

·Trichet signals another rate rise likely in a few months' time but cagey about whether rates nearing peak or if venturing on into restrictive policy zone might be necessary.

EZA Conclusion: Trichet has given a fairly clear indication that rates are still set to rise in two or three months' time but he avoids being drawn on whether further increases are likely beyond that. Failure to clarify where rates become neutral or where policy stance ceases to be accommodative, let alone whether policy might need to become restrictive indicates continuing division within the Governing Council between 'activist' members wanting to maintain the existing pace of tightening and 'gradualists' who might favour a slowing, or even a halt at 4%, as rates approach a likely peak. With GDP growth set to continue above trend and little response of monetary aggregates to past rate hikes, EZA still sees the balance of argument within the Governing Council as pointing to further increases in the 'refi' rate beyond June's likely 4% to 4 1/2% by end-year.

© Graham Bishop