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ECB expected to drop planned September rate hike - extended

Analysis

The European Central Bank is holding a key meeting Thursday with renewed economic uncertainty triggered by global financial market turmoil expected to force the ECB to back away from a planned rate hike.

As a result, the markets’ focus will be on European Central Bank chief Jean-Claude Trichet’s press conference Thursday for comments on how he sees both interest rate policy unfolding in the coming months as well as the economic implications of the turbulence that shook global bourses last month. But just one day before the meeting, the ECB foreshadowed another intervention in financial markets if volatility continued. This came amid signs of fresh investor concerns about the fallout for global economic growth and corporate earnings of the crisis in the US subprime mortgage market following new data which underscored the weakness of the American housing sector.

Four weeks ago Trichet signaled at his regular monthly press conference that the ECB’s 19-head rate-setting council was on course to raising borrowing costs again in September. Trichet told reporters that the bank was maintaining ‘strong vigilance’ on the inflation front, which is ECB code that a rate hike is in the pipeline resulting in analysts factoring in a 25-basis points rise in the bank’s benchmark rate on Thursday. But since then, however world financial markets have been hit by fears that the US housing market crisis would trigger a global credit crunch and derail growth.

More recently, Trichet moved to ensure that the bank had room to move in the run-up to Thursday’s governing council meeting by appearing to keep the ECB’s options open as it sized up the fallout for both the global economy and financial markets of the turbulence which swept across world bourses last month. Trichet once again insisted that the bank was never ‘pre- committed’ when it came to rate decisions with analysts pointing out that the ECB chief had avoided using language flagging a rate increase. “Pulling out of a rate increase will help to stabilize the financial markets,” said Juergen Michels, economist with the US financial house Citigroup.

“At the same time it would reduce the danger that the problems could spread to the real economy.” “Volatility in the euro money market has increased and the ECB is closely monitoring the situation,” the Frankfurt-based ECB said in a statement. Should the volatility persist Thursday, the ECB said it stands ready to contribute to orderly conditions with the bank having joined central banks around the world in pumping money into the finance sector to shore up market confidence.

Also helping the ECB’s somewhat hawkish governing council to agree to call off this month’s rate hike is likely to be official data released last week showing inflation holding at 1.8% in August. Inflation has remained within the bank’s 2% for 12 months in a row. Adding to the pressure on the ECB to abandon the September rate hike are expectations that both the Bank of Japan and the Bank of England will refrain from moves towards higher rates and that the US Federal Reserve might even reduce rates this month. That said, however, the question facing analysts is whether Trichet will use his press conference following Thursday’s meeting to begin laying the ground for the ECB to press on with its rate- setting cycle this year, possibly as early as next month.

If the ECB decides to raise rates again it would lift borrowing costs in the 13-member eurozone to 4.25%. It would also represent the ninth rise since the ECB launched its current rate- hiking cycle in December 2005. The markets will also want to hear some soothing words from Trichet about the risks posed to the eurozone banking system by the shakeout in the US subprime market in particular after its plunged two German banks - collapse of IKB bank and Landesbank Sachsen LLB - into a crisis.

Thursday’s ECB meeting follow a batch of less-than-encouraging key eurozone economic sentiment surveys with the Paris-based OECD revising down its 2007 growth forecast for the currency bloc to 2.6% from a previous prognosis of 2.7%. (m&c.com)

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