14 May 2007

EZA 791 Report: ECB Observer

ECB 10 May Council Post-Meeting Assessment

·As signalled by Trichet last month, ECB kept key rates unchanged on 10 May.

·Tougher language than in April statement, re-introducing strong vigilance is of the essence in place of 'monitor closely', while interest rates still seen as moderate, policy still on the accommodative side and acting in a timely manner is warranted.

·Economic activity seen solid and broad-based in 2007 Q1 and medium-term outlook continues to be favourable, but downside risks remain over longer horizons.

·Statistical effects still expected to push inflation in next few months but to raise it to around 2% towards end of year, with upside risks over policy-relevant medium term.

·Continuing concern at record M3 growth rates and still rapid private sector credit growth.

·Trichet gives clear signal that 25 bp rate rise likely on 6 June and does not close door on further increases (as long expected by EZA) later in 2007.

EZA Conclusion: A 25 bp rate hike in June now virtually a done deal, taking the 'refi' rate to a still broadly neutral 4%. Trichet's refusal to be drawn on what happens after that reflects the pragmatic, evidence-based approach the Governing Council has always adopted and the desire to achieve consensus between its 'activist' members who want to maintain the pace of tightening and the 'gradualists' who favour a slowing as policy comes closer to restrictive territory. Favourable growth outlook and upside inflation risks, with rising capacity utilisation and tightening labour markets, together with stubborn expansion of money and credit, strengthen the 'activist' case for further increases, to a slightly restrictive 4 1/2%, by the end of 2007 as EZA has long foreseen and as markets are now just starting to factor in as a possibility.

© Graham Bishop