02 July 2008

EZA 851 Report: ECB Observer

ECB 3 July Council Preview


1/4% ECB REFI RATE RISE NEAR CERTAIN FOR 3 JULY: INFLATION ALERT WILL CONTINUE DESPITE WEAKER DEMAND: FURTHER HIKE POSSIBLE BY END 2008.

· ECB Governing Council will regard its price stability credentials undermined if it fails to follow up Trichet's June signal that rates highly likely to be raised on 3 July.

· 'Headline' inflation rate has soared to new record of 4% from May's record 3.7%, inflation expectations now more clearly on the rise and external and internal cost pressures go on mounting and pass-through to the domestic price chain continues, increasing risks of second-round wage-price spiral.

· Further mixed signs that economic activity has been slowed significantly in the second quarter, with construction output and retail sales down and confidence in the manufacturing, consumer and service sectors declining further.

· Additional evidence that past official rate hikes and financial market stress are biting on monetary aggregates and credit counterparts, but money and credit growth still uncomfortably high and liquidity overhang goes on widening in nominal terms.

· Financial sector remains troubled and short-term rates stay high as markets now expect official interest rates to rise on Thursday and that rate cuts, as EZA has long argued, are off the agenda for quite some time and that a further increase is possible before end-2008.

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