KBC Flash

ECB: Uncomfortable but unmoved

Fri, May 9 2008, 09:38 GMT
by KBC Market Research Desk

KBC Bank


  • • ECB still faces conflicting forces on interest rates

  • • Trichet continues to emphasize upside inflation threat and downplays growth risks

  • • ECB ‘unanimous’ that current policy stance will meet objectives

  • • We think easing inflation worries and poorer growth will prompt lower rates in Autumn

There was little doubt that the European Central Bank would leave its key policy rates unchanged at 4% following it’s governing council meeting today. Official interest rates have now held steady in the Eurozone for 11 months. As graph 1 below indicates the ECB’s inaction stands in stark contrast to the aggressive measures taken in the US and UK of late. Greater concern about inflation and less fear about economic activity have meant the ECB has not followed the Federal Reserve and the Bank of England.

Comments made by ECB President Jean Claude Trichet at today’s pres conference suggest little likelihood of a change in policy anytime soon. This is not to suggest that the ECB or indeed the Euro area economy is in a comfortable position. Worries about inflation persist, worries which in other circumstances might have led to higher interest rates. On the other hand, the likelihood of a marked weakening in Eurozone activity as 2008 progresses, in different conditions, would argue for a preemptive policy easing. At present, however, the ECB finds itself hemmed in until it becomes completely obvious whether high inflation or low growth is the predominant risk. We discussed the dilemma facing the ECB and the implications for interest rates in some detail earlier this week (ECB Rates, How Far From A Tipping Point?)

Mr. Trichet emphasized today that inflation is still seen as the greater threat at present. The ECB feels extremely uncomfortable about the persistence of high inflation in the Euro area and has taken little comfort from the drop to a 3.3% rate in April from 3.5% in March. Today’s press statement notes that ‘inflation has remained above 3% for the past six months’. To put this in context, inflation previously exceeded 3% in only one month, in May 2001, during the ECB’s stewardship. Today’s statement suggests that the ECB sees inflation ‘gradually declining again’. However, it also argues that ‘in order to ensure that current high inflation rates remain temporary, it is imperative that they do not become entrenched in longer term expectations or lead to broadly based second-round effects in wage and price setting’. So, the ECB remains apprehensive that current price pressures could become permanent.

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This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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