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ECB under pressure to pull back from rate hike plans - analysis

The European Central Bank is facing pressure to pull back from its plans for a September hike in borrowing costs as the economic uncertainty unleashed by recent market turbulence places the ECB’s 19-head rate setting council in a dilemma.

Indeed, since European Central Bank chief Jean-Claude Trichet signaled last month that the bank was gearing up to deliver another 25 basis-points rate increase next month global financial markets have remained jittery as investors scramble to size up the scale of the fall out from the US housing market crisis. Expectations that the ECB plans to maintain a course towards a September rate rise were reinforced Monday when Germany’s central bank, the Bundesbank, which is represented on the ECB’s governing council, described monetary policy in the 13-member eurozone as “tending to be expansionary-oriented.” At the same time, however, analysts see a change of sentiment creeping into the deliberations by the world’s leading central banks as a result increasing the pressure on the ECB to reconsider its plans to deliver next month what would be its ninth rate rise since launching its current rate-hiking cycle in December 2005.

“There is a lot of uncertainty (in the markets and the economy),” said Rainer Guntermann, senior economist with the investment bank Dresdner Kleinwort with many ECB watchers believing that the bank could be forced to delay the September rise if the jittery mood continues to dominate financial markets in the coming weeks. Moreover, part of the problem is that it is still unclear how the credit crisis will unfold or what impact it will have on the global economy, world credit conditions and the international banking sector. A consortium of German banks was forced to step in last week to throw a financial lifeline to a second German bank which has been hit as worldwide credit worries spread. “This is just the tip of the iceberg,” said Dirk Schiereck from the European Business School. With this in mind, the upheaval in markets could be helping to edge central banks towards somewhat uncharted waters.

While the US Federal Reserve is seen as having opened the door to rate cut in September after delivering a surprise 50-basis-points reduction in its discount rate last Friday, analysts see the Bank of Japan delaying any push to ratchet up the cost of money until later in the year. Likewise, markets have priced out a September rate increase by the Bank of England. “This is putting pressure on the ECB’s maintaining a tightening bias,” said Guntermann with a growing number of analysts now believing that if the bank sticks to its guns and hikes in September it could the final increase in the bank’s current rate hiking-cycle. A rise in rates in September would lift eurozone borrowing costs to 4.25% with the ECB having last raised rates in June. However, despite Trichet insisting that the ECB does not “precommit” when it comes to interest rate decisions, having flagged the plans for a September rate rise backing off the increase could represent a test of the relatively youthful bank’s credibility in financial markets.

The ECB only assumed the role of chief custodian of eurozone monetary policy following the launch of the euro in January 1999. But then trying to back out of the September rate rise also risks sparking another round of financial market tension if investors saw a postponement in the increase in borrowing costs as signaling the bank’s worries about the depth of the current debt problems. Few analysts doubt that the market volatility is likely to continue in the coming weeks. “The turbulence is likely to persist for sometime,” said Daniele Antonucci, economist with Merrill Lynch. From the point of view of the world’s monetary authorities, the situation is very fluid, said Antonucci, who added that a measure of confidence is unlikely to return to financial markets until “all the skeletons are out of the closet.” More to the point, another period of market turmoil might force the ECB’s hand, resulting in it having to pull back from the September rate rise. Added to this could be growing doubts about how eurozone growth will pan out this year with figures also showing the housing prices in the currency bloc slowing as the accumulation of rate rises start to bite.

Official data released last month showing economic growth in the eurozone easing during the Q2 has raised the prospects of economists revising down their 2007 growth forecasts for the currency bloc with some pointing to financial market volatility as a reason for downgrading growth outlooks. (monstersandcritics.com)