11 December 2006

EZA 771 Briefing Note: ECB Observer

ECB 7 December Council Post-Meeting Assessment

·As widely anticipated, ECB raised key rates by 25 bp on 7 December.

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

·Surprising omission of last month's 'if ECB's assumptions and baseline scenario continue to be confirmed it will remain warranted to further withdraw monetary accommodation.

·Eurosystem Staff projections revise growth up and inflation down, with mid-point estimates for growth of 2.7%, 2.2% and 2.3% in 2006, 2007 and 2008 respectively and inflation at 2.2%, 2.0% and 1.9%.

·Downside risks to growth remain but inflation still subject to upside risks, including danger of inflationary wage settlements.

·Continuing concern at rapid growth of M3 and of lending to companies and households, against background of improved economic conditions and ample liquidity.

EZA Conclusion: Trichet has given a fairly clear indication that rates are still set to rise in 2007 but he avoids being drawn on how much further and when. 'Monitor very closely' would, on past form, signal +25 bp in two months' time (ie 8 February) but omission of 'further withdrawal' could signify an emerging division within the Governing Council between some members wanting to maintain the existing pace of tightening and others who might favour a slight slowing as rates approach a likely peak, which EZA still expects to be 4 1/4%-4 1/2% by end-2007. Our central view is that the next rise will be +25 bp to 3 3/4% on 8 March although, if present monetary concerns were to hold sway over uncertainty about concrete demand pressures, 8 February is still possible.

© Graham Bishop