The European Central Bank is almost certain to raise its key interest rates to a five-and-a-half-year high next week to curb inflation in the eurozone economy, as it currently enjoys a robust upturn, analysts here said on Friday.
The ECB's rate-setting governing council, meeting next Wednesday in the bank's Eurotower headquarters in Frankfurt, is unanimously expected to raise its benchmark "refi" refinancing rate by a quarter of a percentage point to 4.0 percent. It will be the eighth such rate rise since December 2005 and will bring the refi to its highest level since September 2001.
At the bank's last monthly meeting in Dublin in May, ECB chief Jean-Claude Trichet left little doubt that monetary conditions in the 13 countries that share the euro are set to become tighter. The Frenchman insisted that "strong vigilance" was required with regard to inflationary risks in the eurozone economy. The term "strong vigilance" is understood by financial markets as Trichet's codeword for signalling an imminent rise in rates.
While area-wide inflation remains below the ECB's ceiling of 2.0 percent, Trichet has warned of upward price pressures in the medium term as wage deals come out higher than gains in productivity. And such dangers could increase as the economic upturn continues and employment levels rise, the ECB chief believes. On Thursday, a survey published by the EU Commission in Brussels found that confidence in the European economy was the strongest in six years in May, despite the prospect of higher interest rates, firm oil prices and the euro's current strength. "We are optimistic that Europe will be able to sustain its recent economic revival," the head of the European Commission's economic department, Klaus Regling, said. And in a recent report, the Paris-based Organisation for Economic Cooperation and Development (OECD) predicted that the single currency area would run up growth of 2.7 percent this year, outpacing anticipated expansion of the US economy for the first time since 2001.
The OECD also warned that higher interest rates might be needed to keep inflation down. With a rate increase next week considered almost a done deal, the markets will be listening out for clues as to whether the cycle of monetary tightening will continue in the coming months, analysts said. "As almost everyone expects the ECB to raise the refi to 4.0 percent on Wednesday, investors are likely to concentrate on possible hints about the future course of monetary policy," said Commerzbank chief economist, Joerg Kraemer. Bundesbank President Axel Weber, who sits on the ECB's governing council, left no doubt recently that further rate hikes were indeed on the cards.
"The current cycle of interest rate hikes has not reached its end," Weber told the Financial Times in interview. "What is pretty clear at the moment is that we are in a stronger than previously expected recovery. If necessary we will also have to move into a territory that is portrayed as being restrictive, if that is needed to control inflation," Weber said. Trichet might not be so willing to be quite so explicit at next week's press conference, said Commerzbank's Kraemer. "The ECB will probably leave the door open for further tightening, without giving too many concrete signals," he said.
Bank of America economist Holger Schmieding predicted that the ECB would adopt a wait-and-see attitude. After raising the refi to 4.0 percent next week, "the ECB will come out with a non-committal statement," he said. "I expect the ECB to be on hold in September, but to raise rates well beyond 4.0 percent next year if a rebound in the US economy and the US dollar as well as the expected firming of core European consumption keep eurozone growth above trend in 2008," Schmieding said.
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