04 September 2006

EZA 757 Report: ECB Observer

ECB Council Post-Meeting Assessment (31 August 2006).

·As expected, ECB left key rates unchanged on 31 August, but strong hints of October hike.

·Interest rates still 'low', policy still 'accommodative', 'strong vigilance' replaces last month's 'monitor very closely' and 'acting in a timely manner remains essential'.

·Trichet again says if ECB's baseline scenario continues to be confirmed 'a progressive withdrawal of monetary accommodation will remain warranted'.

·ECB Staff revise growth and inflation projections upwards, with mid-point estimates for growth of 2.5% and 2.2% in 2006 and 2007 respectively and inflation at 2.4% and 2.4%.

·Growth seen as broadening and becoming more sustained but longer-term downside risks had augmented while inflation risks remain clearly on the upside.

·Trichet still downplaying recent slowing of monetary growth, given rapid past trend, continuing double-digit credit growth and stronger economic growth.

EZA Conclusion: Trichet has given a fairly clear indication that the Governing Council is likely to raise rates again - by the usual 25 basis points - at its next monetary policy meeting, on 5 October in Paris. Although downside risks to growth may have augmented, provided evidence continues to accumulate that the economic recovery is being sustained in line with the ECB's baseline scenario - which now factors in the upward revision of the Staff's growth and inflation projections - further rate increases are to be expected as the ECB proceeds with its 'progressive withdrawal of monetary accommodation'. Given that the ECB appears to be shifting now to a bi-monthly rather than quarterly rhythm, EZA continues to see the next move - again by 25 bp - as likely to come in December, bringing the 'refi' rate to 3 1/2%. Provided the eurozone economy continues to develop in line with the Staff's projections, we still see further tightening, with a pause at a 'neutral' 3 3/4% or 4%, during the first half of 2007. However, if 'headline' inflation remains stubbornly high or inflation expectations start to drift upwards, tightening is likely to continue, with the 'refi' rate reaching 4 1/4% - 4 1/2% in the latter part of 2007.

© Graham Bishop