European Central Bank eyes key interest rate hike

Discussion in 'Wall St. News' started by S2007S, Mar 6, 2007.

  1. S2007S


    March 6, 2007, 12:12PM
    European Central Bank eyes key interest rate hike

    Associated Press

    GENEVA — The European Central Bank is expected to increase its key interest rate on Thursday, but investors are likely to be more interested in what bank president Jean-Claude Trichet says than what he does that day.

    Their interest has been piqued by the volatility that roiled markets following former Federal Reserve Chairman Alan Greenspan's comment last week that the United States could be in a recession by the end of the year.

    A plunge in Chinese markets spread like a virus across Asia to Europe and the United States, and back around again and again before equities seemed to steady today.

    The ECB, which sets monetary policy for a 13-nation economy of 317 million people and more than 15 percent of global gross domestic product, is expected to go ahead Thursday with an increase in its key interest rate from 3.5 percent to 3.75 percent.

    In a survey of 55 financial institutions by Dow Jones Newswires, all expected the rate increase to go forward Thursday. Of those, 34 expected the rate to reach 4 percent by June.

    Analysts believe that despite the markets' volatility and worries about a possible global slowdown, the ECB will focus on keeping inflation in the euro zone contained.

    Inflation in the 13 euro nations was estimated at 1.8 percent for February, data from the European Union's statistics agency showed. That was unchanged from January, and below the European Central Bank's just-under 2 percent guideline. Some saw it as news that could hamper the case for a rise in interest rates.

    But at last month's meeting of the Governing Council, Trichet said that "strong vigilance remains of the essence so as to ensure price stability."

    That, said Carl Weinberg, chief economist of High Frequency Economics, was a signal that an increase will come this week.

    "Traders are treating this rate hike as assured," he said. "So are we."

    But would an increase cause heartburn for the markets? Yes and no. A raise would further strengthen the euro and likely draw criticism from some European politicians — notably the French — who fear a strong currency could hurt their exports.

    Markets could just as easily see the increase, the seventh since December 2005 when the rate was 2 percent, as a sign of stability that could help ease the fears of traders.

    "After the sharp downward correction in market expectations of future ECB policy, we see a clear risk that the ECB may be as dovish as markets are now hoping for," said Holger Schmieding, a European analyst with Bank of America in London. "While the ECB may confirm that it is watching markets closely, the ECB will probably explain that the plunge in stock prices and the spike in volatility so far pose no major threat to the economic outlook, especially as markets may have underpriced risks in the past."

    He, along with others, said the bank's governing council may even go so far as to lower its inflation forecast for the rest of the year from just around 2 percent to as low as 1.8 percent. If so, such a move would mirror that of the European Commission which revised its 2007 forecast from 2.1 percent to 1.8 percent, compared to 2.2 percent in 2006.

    Part of that comes from lower-than-expected energy prices, but Trichet, and other members of the council, have said they are worried that stronger money growth could kick inflation higher in the long-term. So far, according to the bank, their preferred measure of money supply in December and January rose at its fastest rate in 17 years, spurring their concern.

    They also fret that the recent declines in unemployment, notably in Germany where the jobless rate has dipped to 10.1 percent, could embolden unions to seek higher pay raises. That would speed inflation, too. IG Metall, the German union that counts some 3.4 million members in Europe's biggest economy, is demanding a 6.5 percent increase in wages this year.

    "This week, an ECB move to 3.75 percent is a done deal," Marco Valli and Chiara Corsa, analysts with UniCredit said in a research note. They stressed that last month's meeting brought to bear the concerns about wage increases and that growth is expected to rise to 2.4 percent from 2.2 percent this year and at 2.3 percent in 2008.