ECB flags March rate hike

The European Central Bank held its key rates steady as expected on Thursday, but ECB chief Jean-Claude Trichet issued a strong hint that borrowing costs could rise next month in order to keep a lid on inflation in the 13 countries that share the euro.
At its regular monthly rate-setting meeting, the ECB held the minimum bid rate for its regular refinancing operations steady at 3.50 percent. And it also held its two other key rates — the deposit rate and the marginal lending rate — unchanged at 2.50 percent and 4.50 percent respectively.
Earlier in London, the Bank of England also maintained its key rates at 5.25 percent.
Nevertheless, at the news conference afterwards, ECB president Trichet left no doubt that the guardian of the euro would tweak rates higher next month in order to nip inflationary pressures in the bud, as the current economic upturn in the single currency area continues apace.
He did so by re-introducing a key phrase that has been absent from his remarks for the past two months.
“We will be strongly vigilant in order to ensure that risks to price stability over the medium term do not materialise,” Trichet said.
The use of the term “strong vigilance” is widely seen as Trichet’s code-word for preparing the markets for a rate hike the following month.
And ECB watchers said that the re-appearance of what they called the “V-word” in Trichet’s comments this time round paved the way for another rate hike in March.
The ECB has raised eurozone borrowing costs six times since December 2005, last time on December 7, 2006.
And each time, the term “strong vigilance” has been used by the bank to flag the move the month before.
With the re-appearance of the term this month, “the ECB calmly confirmed today that it intends to raise rates to 3.75 percent in March,” said Bank of America economist Holger Schmieding.
Trichet said that even at 3.50 percent — the highest level in five years — the ECB’s monetary policy stance remains “accommodative” and eurozone interest rates were still “low.” And the risks to price stability were still firmly on the upside, the ECB chief said.
Among the risks were the upcoming wage agreements across the eurozone.
Unions in Germany, for example, have signalled they will demand large wage increases in this year’s annual round of pay talks given record corporate profits and the booming German economy.
The ECB would therefore “monitor the upcoming wage negotiations in the euro area very carefully,” Trichet said.
Also a potential inflationary threat was very strong monetary and credit growth, as shown in the record-high money supply growth and the possibility of renewed increases in oil prices, Trichet said. Furthermore, the growth outlook for the 13 countries that share the euro remained “solid and broad-based,” the ECB chief said. With a move in March more or less a done deal, the question for most ECB watchers was whether further rate hikes would on the cards after then.
Schmieding at Bank of America found “no clear guidance” in Trichet’s remarks.
“Our impression is that the ECB probably has no internal consensus yet on rate policy beyond March,” the analyst said. He predicted that after March, the ECB would hold rates steady until the autumn, “followed by further increases to a rate peak of 4.25 percent in January 2008 at the latest.”
WestLB economist Alexander Krueger said he expected the ECB to raise its refi again to 4.0 percent in June and then pause in the tightening cycle.
But IXIS economist Luca Silipo disagreed, projecting no further rate hikes after March.
“The economic slowdown in the first quarter will probably be stronger and more widespread than the ECB expects,” the analyst argued.
Commerzbank chief economist Joerg Kraemer agreed and said he also disagreed with the ECB’s assessment that headline inflation would tick upwards in 2007.
Area-wide inflation “should fall below 1.5 percent in the spring and remain below 2.0 percent in the second half of 2007,” Kraemer said.
The ECB sees 2.0 percent as the maximum tolerable level of inflation.

Copyright AFP (Agence France-Presse), 2006