ECB, Bank of England opt for Steady Rates

Posted 07 July 2006 @ 06:35 pm EET     Print     Reprint     E-Mail     Comments

Frankfurt (AP) - Both the European Central Bank and the Bank of England have opted to hold their key interest rates steady, but monetary conditions look set to tighten both in Britain and mainland Europe as early as next month as economic activity gathers pace.

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For its part, the ECB sent a strong signal Thursday that a rate hike was on the cards at the beginning of August, while analysts in London said the latest growth data pointed to higher rates in Britain next month as well.

As widely expected, the guardian of the euro held the minimum bid rate for its regular refinancing operations steady at 2.75 percent, after raising it by a quarter of a percentage point last month. In London, the Bank of England also held its key rate steady at 4.50 percent.

However, in Frankfurt, Trichet took financial markets and most ECB watchers by surprise by strongly hinting that a further rate hike was likely at the start of next month. The ECB is scheduled to meet to discuss interest rates twice in August: on August 3 and again on August 31.

Until now, most analysts had ruled out a move at the earlier meeting because the meeting was to have been held by means of a teleconference and was not to have been followed by a news conference.
But in a surprise announcement, Trichet revealed that the governing council would meet in person after all on August 3.

"We have decided to meet physically on August 3, instead of via teleconference and there will be a news conference afterawards," Trichet said. Furthermore, the Frenchman said the guardian of the euro would exercise "strong vigilance" with regard to potential inflationary risks in the eurozone.

"We will exercise strong vigilance so as to ensure that risks to price stability over the medium term do not materialise," he said. "Strong vigilance" is seen by ECB watchers as a signal that the guardian of the euro is planning to tighten monetary conditions in the single currency area imminently in order to keep a lid on inflation.

"He used the 'V'-word, so we're expecting a quarter-point move on August 3," said NordLB analyst, Bernd Krampen. Commerzbank economist Joerg Kraemer noted that "since the beginning of this year, the ECB has always raised the refi rate one month after it had used the word 'vigilance' for the first time.

"This makes it very likely that the ECB will hike the refi on August 3 and not on August 31 as most people had been expecting," Kraemer said. "This notion is also supported by the fact that the governing council has decided to meet not by teleconference but in person and the fact there will be a press conference."

Societe Generale analyst Frederic Pretet said that by holding a news conference, "the ECB will now be able to communicate clearly its motivation for accelerating the tightening pace and what it implies for the management of monetary policy."

Trichet insisted that further action on rates was necessary in order to nip inflationary pressures in the bid. "Acting in a timely manner to contain (price) risks remains essential to ensure that inflation expectations in the euro area are kept solidly anchored at levels consistent with price stability," he said.

And with even after raising eurozone borrowing costs by three quarters of a percentage point since December, interest rates were "still low in both nominal and real terms ... and our monetary policy continues to be accommodative."

And he added: "A progressive withdrawal of monetary accommodation remains warranted," even if the bank had not decided in advance on the pace and magnitude of future rate moves. Trichet appeared to rule out a bigger half-point rise in rates. "On the matter of 50 basis points, there is no sentiment (within the ECB) that we should do something which would be different from the previous decisions we took," he said.

Bank of America economist Holger Schmieding also believed it was unlikely that the ECB would both accelerate the pace of monetary tightening and increase the size of the rate hike in one go. However, ECB rates were now set to stand at 3.25-3.50 percent by the end of this year.
"And next year, the ECB will raise rates only modestly and will probably do so only if the eurozone economy holds up well," Schmieding said.