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Upward moves by Bank of England and ECB in offing

Thu, Jun 7 2007, 09:59 GMT
by Economic Research Dept.

La Caixa

As expected, the Governing Council of the European Central Bank (ECB) decided to maintain its reference rates stable at its meeting on April 12. Nevertheless, in its analysis of the economic and financial situation it recognized that there continued to be upward risks for inflation. In fact, harmonized inflation for the euro area rose to 1.9%, close to the limit set by the ECB. At the same time, the broad money supply figure for the euro area, the socalled M3, recorded annual growth of 10.0% in February, the highest level since the introduction of the euro,more than twice the reference growth rate set by the ECB.

In this context, chairman Jean-Claude Trichet mentioned that interest rates were still at a moderate level and he suggested that a new tightening of the monetary policy screw was near and likely would take place at the beginning of June. This prospect does not please everyone and the representative of a well-known European business lobby launched warnings against any increases above the 4% level. Nevertheless, it would not be surprising if this takes place in the second half-year.

On the other side of the English Channel, current legislation obliged the governor of the Bank of England, Mervyn King, to write to the minister of economy, Gordon Brown, explaining the reasons for a deviation in inflation of more than one percentage point from the 2% established, as well as the measure he proposed to take to correct the rise in prices. This is the first time this has happened in the nearly ten years that the British central bank has been independent. The governor of the central bank recognized that there had been the conditions for companies to try to raise their profit margins, which had been squeezed as a result of the last rise in oil prices. King expressed his determination to put inflation at 2% which he felt he could do toward the end of the year, although he indicated there were some upward risks. In these circumstances, there were renewed forecasts of a further increase in Bank of England reference rates at the next meeting in May, which would put it at 5.50% and that this would not be the last increase.

The US Federal Reserve, in turn, had no meeting planned for its monetary policy committee in April. Statements by Ben Bernanke in recent weeks, along with the latest minutes released, have reaffirmed his concern about inflation and, to a lesser degree, about growth. As a result, we maintain our predictions of stability for upcoming meetings which, however, could lead to a downward adjustment in the last four months of the year.

On the other side of the Pacific, the governor of the Bank of Japan, Toshiniko Fukui, stated before parliament that Japan’s monetary conditions continued to be very easy and indicated a gradual course of increases in interest rates. Nevertheless, we did not believe that the next increase would take place at the meeting on April 27 but that it would likely be in the summer.

On the other hand, more to the south of the Asian continent there were indeed new moves. At the end of March, the Bank of India announced an increase of 25 basis points in its invention rate putting it at 7.75%, thus continuing the upturn begun in September 2004. At the same time, it raised the cash ratio by a half-point to 6.50%. These measure are aimed at dealing with inflationary trends in an economy with signs of overheating, such as an annual inflation rate of 7.6%, according to the industrial workers’ index, and annual growth of credit at 29.5% in an environment of optimism reflected, in another sphere, the euphoria recently set off by the lavish wedding of two Bollywood film stars, Abhishek Bachchan and Aishwarya Rai, a former Miss World. Given the slow rate of needed structural reforms, new restrictive moves in monetary policy are likely in order to cool off the economy.

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Published on  Thu, Jun 7 2007, 10:47 GMT