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ECB may raise benchmark rate, leave door open for another step

The European Central Bank may raise its benchmark lending rate for the seventh time since late 2005 and leave open the possibility of another increase, surveys of economists show.

European Central Bank policy makers meeting in Frankfurt today will increase the rate by a quarter point to 3.75%, according to all 38 estimates in a Bloomberg News survey. While economists expect another increment in June, investors have pared bets on a further increase. The ECB has indicated it wants to curb inflation in the 13-nation euro region by removing „monetary accommodation” and taking rates to a level that no longer stimulates the economy.

With inflation below the bank's 2% limit and growth showing signs of slowing from the fastest pace in six years, some investors say the central bank will reach that point today. „If the ECB says rates are still `accommodative,' it could throw markets into a spin as they quickly price in a move to 4% again,” said Uwe Angenendt, chief economist at BHF-Bank AG in Frankfurt.

„This will be an explosive meeting.” The bank will announce its decision at 1:45 p.m. and President Jean-Claude Trichet will hold a press conference 45 minutes later. The implied rate on the three-month Euribor futures contract for September was 4.03% yesterday, down from 4.17% on January 29. The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 16 basis points more than the ECB's benchmark rate since the single currency's start in 1999.


Much will hinge on the ECB's latest economic forecasts, also due to be published today. If they suggest inflation will accelerate in 2008, the bank will keep the door open for further increases, said Steve Webster, chief European economist at 4Cast Ltd. in London. The ECB currently forecasts inflation of about 2% this year and 1.9% in 2008. Policy makers are „still concerned about a resurgence in inflation later this year,” said Webster. „They will raise rates to 4% in June unless we get some catastrophic volatility in markets.”

Global equity markets are recovering from a sell-off that wiped €2.5 trillion ($3.3 trillion) off stock values around the world in six days. That was caused in part by concern that growth in the US economy, the world's largest, is slowing. Waning demand for exports and a higher sales tax in Germany may crimp euro-region economic expansion this year. Retail sales in Germany, Europe's largest economy, plunged 5.1% in January from a month earlier and factory orders unexpectedly dropped 1% as export demand declined.


Still, with the expansion accelerating more than economists expected in the fourth quarter of 2006, the ECB may revise up its growth estimate for this year, ECB council member Nicholas Garganas suggested in an interview published February 27. The bank currently projects expansion of about 2.2% this year after 2.6% in 2006, the most since 2000. The European Commission on February 16 forecast a slowdown to 2.4% in 2007.

The economy „is on a solid, stable growth path,” ECB council member Axel Weber said February 28. „We must therefore further withdraw monetary stimulation from the economy.” Policy makers have said in the past that the so-called neutral interest rate, the level that neither stimulates nor restrains growth, lies between 3.5% and 4%.


Inflation slowed to 1.8% in February, holding below 2% for the sixth straight month and putting the ECB on course to achieve its inflation goal in 2007 for the first time since 1999. The bank is concerned workers' demands for wage increases will reignite inflation as companies post record sales and profits. IG Metall, Germany's biggest labor union, is demanding a 6.5% pay increase for as many as 3.4 million workers, defying ECB calls for wage restraint.

At the same time, M3 money supply, which the ECB uses as a gauge of future inflation, rose 9.8% from a year earlier in January, the fastest pace in 17 years. „The risks to inflation are clearly on the upside, and are growing,” Garganas said. „How far do you need to go with rates when you know that stronger growth hasn't so far translated into stronger inflation?” said Sandra Petcov, an economist at Lehman Brothers International in London. „We expect hawkish language from the ECB, but it's not ready yet to signal what it will do next.” (Bloomberg)