Prospects for a hike in eurozone interest rates grew Thursday after the European Central Bank said that money supply, a key yardstick of future inflation, grew more strongly than expected in May. The M3 money supply grew by 10.7 percent on an annualised basis in May, up from 10.4 percent in April, the ECB calculated in a statement.
The ECB closely monitors developments in the money supply when deciding the appropriate level of interest rates because it sees a link between the level of liquidity in the economy and future inflation.
The guardian of the euro calculates that the money supply needs to expand by an annual 4.5 percent to serve as a basis for non-inflationary economic growth.
But the current rate of M3 growth is more than double that.
Indeed, M3 money supply, which covers cash, overnight deposits, other short-term deposits, repurchase agreements, shares and units in money market funds and debt securities with a maturity of up to two years, has been growing much faster than the ECB would like for around six years.
Because the monthly figures are subject to volatility, the ECB also calculates a three-month moving average for M3 growth.
And that picked up last month, accelerating to 10.7 percent in the period from March to May from 10.4 percent in the period from February to April. With current economic indicators pointing up and inflationary dangers also high as a result of high energy prices, the ECB is paying a great deal of attention to monetary developments and has used them as justification for its decision to raise its key interest rates eight times since December 2005.
The ECB last raised its key rates by 0.25 percentage points to 4.00 percent earlier this month and is expected to tighten monetary conditions again in September. "Following several years of robust monetary growth, the liquidity situation in the euro area remains ample. In this environment, monetary developments continue to require very careful monitoring, particularly against the background of the expansion in economic activity and still strong property market developments," the ECB wrote in its June monthly bulletin. In its statement on Tuesday, the ECB calculated that loans to the private sector, another key yardstick of future inflation, grew by 10.3 percent in May, the same rate of change as in April.
And the annual rate of growth of lending for house purchases was steady at 8.6 percent in May, also unchanged from the previous month, the ECB data showed. ECB watchers were convinced that the latest data would add to the case for further monetary tightening.
"The money supply side is a real cause for concern to policymakers. With liquidity growth running at more than double the ECB's 4.5-percent safety speed limit, the clamour should grow for higher rates and tougher policy," said Bear Stearns economist, David Brown.
He said ECB council members would be looking to raise rates to 4.25 percent at their September meeting and to a peak of 4.50 percent later in the year. Global Insight analyst, Howard Archer, agreed.
"The May eurozone money supply and credit growth data make pretty disappointing reading for the ECB, keeping another 25 basis point interest rate hike to 4.25 percent firmly on the cards for September. Furthermore, it remains highly possible that interest rates could reach 4.50 percent around the turn of the year," he said.