The European Central Bank’s main lending rate is already „above target,” keeping the bank from further increases, the European Economic Advisory Group said.
„The ECB is now standing at a crossroad,” the coalition of economists said today. „Are inflation expectations and growth prospects still high enough to warrant another rise, or should the interest rate be cut to cope with the forecasted mild slowdown? We assume that the different tendencies will balance each other.” The European Central Bank has already signaled it’s ready to raise the key rate further next month after six increases to 3.5% since late 2005. ECB council member Nicholas Garganas said in an interview yesterday that monetary policy is still „accommodative” with stronger economic growth threatening to fuel inflation.
The Frankfurt-based ECB expects the economy of the 13 nations sharing the euro to expand about 2.2% this year. Inflation may average around 2%. The bank aims to limit annual gains in consumer prices to just below 2%. Adding to the ECB’s concerns, M3 money supply, which the bank uses as a gauge of future inflation, rose 9.8% from a year earlier in January. That’s the highest level since February 1990. Garganas said in the interview before the report on M3 was published today that „risks to inflation are clearly on the upside, and are growing,” indicating that he’s in favor of raising the benchmark interest rate further.
„Nevertheless, given the rhetoric of the ECB, stressing the upward risks with respect to inflation due to the abundant liquidity in the euro system as well as oil price and wage developments, we expect a constant refinancing rate at 3.5%” through 2008, the EEAG said. The current rate already exerts effects that could lead to an economic contraction.
Today’s report echoes remarks by European Union finance ministers in Brussels yesterday when they suggested they don’t see the need for further rate increases. At least in the short-term, inflation „does seem under control,” Luxembourg Prime and Finance Minister Jean-Claude Juncker said. Spain’s Pedro Solbes said „inflation is improving all over Europe.”
The EEAG expects the 27-member European Union to expand 2.2% this year and 2.5% in 2008, according to today’s report. Inflation may average 2.2% in 2007 before cooling to 1.9% in 2008, it said. Investors have already pared bets on the ECB raising its key rate to 4% after March, futures trading shows. The implied rate on the three-month Euribor futures contract for September was at 4.1% today, down from 4.14% on February 1.
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 currency’s start in 1999. The EEAG is a global research network of more than 570 university professors in 30 countries. Its home base includes the Ifo economic research institute in Munich. (Bloomberg)