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ECB: Rate hike postponed for now

Fri, Sep 7 2007, 08:18 GMT
by Allan von Mehren, Niels-Henrik Bjørn

Danske Bank A/S

The ECB Governing Council chose to leave the policy rates unchanged at today’s meeting. Following the August 2 meeting, when Trichet cautiously indicated a rate hike in September, it was not clear whether the ECB would be on hold this month amid the financial turmoil. However, the decision to leave rates on hold probably reflects the inherent uncertainty about the causes, extent and implications of this turmoil.

After all, the economic and inflation outlook does not exactly beg for a significantly tighter policy at the moment, and so there’s real value for the ECB in waiting to make a decision.

At the press conference, the ECB maintained its base scenario. In particular the ECB still holds the following views:

1. 1. Monetary policy remains on the accommodative side
2. 2. The economic outlook is still favourable
3. 3. Risks to price stability are on the upside (a new risk was introduced: food prices)
4. 4. The economic analysis is confirmed by an almost unchanged monetary analysis.

These views were backed by new forecasts that predicted the same level of GDP growth and inflation in 2008 as was predicted in June. As a consequence of this fundamental base scenario, the ECB maintained a significant tightening bias as reflected in the statement that the ECB will monitor prices “very closely”. This sentence has earlier been used to say that the ECB is not far away from tightening policy.

However, the ECB also stressed that the financial turmoil had increased uncertainty surrounding this base scenario. The lack of tightening must thus be seen in the light of this increased uncertainty. The ECB said also that more data was needed before deciding on the policy course. More concretely the ECB stressed that inflation risks continued to be the needle of the compass in its policy, and that the ECB would certainly not balance upside risks to price stability with downside risks to economic growth. All in all, the ECB is in a position of wait-and-see.

It does not take much to make the ECB tighten again. If calm returns to the markets and economic data over a couple of months confirm ECB’s main scenario, we believe that the ECB will tighten policy again. However, we are also aware that economic data at the moment only indicate very cautious tightening. We maintain our forecast of the ECB raising rates in Q1 and Q2 next year.

At the press conference ECB also said that it would do an extra 3-month tender on September 11. This is a clear step to try and alleviate the problems in the interbank market where rates have kept going up the last week. Contrary to the last 3-month tender it has not set the amount it will allot in advance. This gives ECB more flexibility to control the rate of the tender as it can give as much money it wants to get down to a rate level it finds appropriate. The question is how much money ECB is willing to give, but this is a chance for the banks that are struggling to get funding through the market to get it through ECB. This is clearly a positive step but whether it is enough is still the question.

• ECB: Rate hike postponed for now

Published on  Fri, Sep 7 2007, 08:18 GMT