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ECB threatens July rate rise

Fri, Jun 6 2008, 14:27 GMT
by KBC Market Research Desk

KBC Bank

• • Trichet suggests rate rise likely next month
  

• • ECB to act as inflation likely to star higher for longer
  

• • Threat of further increases likely to hang over interest rate markets
  

• • ECB adopting a very high risk strategy
  

• • Higher interest rates unlikely to alter food or fuel costs…but could damage a clearly weakening Euro Area Economy
  

Today’s European Central Bank decision to leave its key policy rate unchanged at 4.00 for a twelfth consecutive month did not come as a surprise to financial markets. However, Mr. Trichet’s warning that rates could rise as soon as next month certainly did.

The indication that interest rates could rise a early as next month is probably the biggest shock the ECB has delivered to financial markets in its 9 ½ year history. Traders had looked to the ECB’s monthly press conference for some guidance on the outlook for Euro area interest rates. In the past month or so, hopes for lower rates had all but vanished. Instead, the markets had begun to price in the prospect of an increase in official rates in the Autumn. In these circumstances, investors looked forward to Mr. Trichet’s pronouncement today but there was little expectation of the fireworks he delivered.

The monthly press statement was more hawkish than expected. However, Mr. Trichet went a great deal further in responding to questions than the tone of the opening press statement had suggested. In today’s Q & A session, he said that a number of the ECB council wanted to raise rates today and suggested that the ECB “could move a small amount in July”. While he said it was not certain that rates will rise next month, he made it more than clear that ‘it’s possible to move in July’.

Mr. Trichet went so far today in preparing the market for a rate rise in July that it is difficult to see what would make the ECB decide against hiking rates next month. A failure to raise rates would leave markets completely lost as to what determines ECB policy and communications. Furthermore, the ECB’s much wanted medium term focus means that the vagaries of monthly data between now and the next policy meeting on the 3rd of next month should not dramatically alter ECB thinking. Hence, in sharp contrast to our earlier expectations, it now looks very likely that interest rates are set to rise next month.

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Published on  Fri, Jun 6 2008, 14:39 GMT