Trichet may ditch rate rise as Europe inflation surges
European prices are accelerating at the fastest rate in two years. Jean-Claude Trichet may abandon the European Central Bank’s drive to raise interest rates anyway.
By Agencies |
PARIS: European prices are accelerating at the fastest rate in two years. Jean-Claude Trichet may abandon the European Central Bank’s drive to raise interest rates anyway.
The ECB president, forced to pick sides within his divided governing council, is likely to support keeping the bank’s main rate at 4% this week — and probably for months to come, economists predict. If history is any guide, his next move may even be a rate reduction. For now, the ECB’s 19-member council, meeting in Frankfurt on November 8, is in what David Brown of Bear Stearns International describes as a “holding pattern”.
Inflation stands in the way of cutting rates, while weaker economic growth blocks the increase Trichet had intended as recently as two months ago.
“Downside risks have risen to such an extent that the ECB is now prevented from raising rates,” Royal Bank of Scotland chief euro-area economist Jacques Cailloux said. “As the economy continues to disappoint, it’ll start opening the door to a rate cut.” Such a strategy would mean Trichet, 64, is betting that Europe’s weakening economy and the euro’s rise to a record against the dollar will ultimately haul inflation back into line.
His room to manoeuvre is also limited by the US Federal Reserve’s rate cut last week, its second in two months. Economic growth in the euro region will likely slow to about 2.5% this year after a 2.8% expansion in 2006, the most in six years, the ECB forecast in September. The central bank sees a 2.3% expansion in 2008.
“The ECB is trapped between conflicting forces,” Bear Stearns’s London-based chief European economist Brown said. “When the policy bias eventually swings, it should shift away from tightening to easing.” That’s what happened at the Fed after it stopped raising rates in June 2006. For the next 14 months, it continued to insist that inflation was the greatest risk while leaving rates unchanged during that entire period.
It finally changed both its tune and its policy in September, cutting rates after defaults in the US subprime-mortgage market led to a collapse in commercial credit. The ECB may be in a similar period after market turmoil wrecked Trichet’s plan to boost the benchmark rate to 4.25% in September and prompted economists to scrap forecasts for it to reach 4.5% by year-end.
Investors now price in no more rate changes this year and a 15% chance of an increase by the middle of next year, according to money-market trading. The median estimate of 30 economists surveyed by agencies is that Trichet will leave rates unchanged throughout 2008. The economists in the survey project fourth-quarter growth in the 13 nations sharing the euro will slow to a 2.1% annual rate from an estimated 2.5% in the third quarter. Some ECB officials still want to keep open the option of raising borrowing costs.
Data last week showed that consumer prices rose at a 2.6% annual rate in October: That was the most in two years, and the second month of increases exceeding the ECB’s aim of “close to, but below” 2%. Prices may climb further as oil sets records over $93 a barrel and the price of food, including milk and wheat, surges.The inflation outlook in the euro region “is subject to upside risks”, Axel Weber, president of Germany’s Bundesbank and a member of the ECB’s governing council, said in an October 30 speech in Giessen, Germany.
The ECB president, forced to pick sides within his divided governing council, is likely to support keeping the bank’s main rate at 4% this week — and probably for months to come, economists predict. If history is any guide, his next move may even be a rate reduction. For now, the ECB’s 19-member council, meeting in Frankfurt on November 8, is in what David Brown of Bear Stearns International describes as a “holding pattern”.
Inflation stands in the way of cutting rates, while weaker economic growth blocks the increase Trichet had intended as recently as two months ago.
“Downside risks have risen to such an extent that the ECB is now prevented from raising rates,” Royal Bank of Scotland chief euro-area economist Jacques Cailloux said. “As the economy continues to disappoint, it’ll start opening the door to a rate cut.” Such a strategy would mean Trichet, 64, is betting that Europe’s weakening economy and the euro’s rise to a record against the dollar will ultimately haul inflation back into line.
His room to manoeuvre is also limited by the US Federal Reserve’s rate cut last week, its second in two months. Economic growth in the euro region will likely slow to about 2.5% this year after a 2.8% expansion in 2006, the most in six years, the ECB forecast in September. The central bank sees a 2.3% expansion in 2008.
“The ECB is trapped between conflicting forces,” Bear Stearns’s London-based chief European economist Brown said. “When the policy bias eventually swings, it should shift away from tightening to easing.” That’s what happened at the Fed after it stopped raising rates in June 2006. For the next 14 months, it continued to insist that inflation was the greatest risk while leaving rates unchanged during that entire period.
ADVERTISEMENT
It finally changed both its tune and its policy in September, cutting rates after defaults in the US subprime-mortgage market led to a collapse in commercial credit. The ECB may be in a similar period after market turmoil wrecked Trichet’s plan to boost the benchmark rate to 4.25% in September and prompted economists to scrap forecasts for it to reach 4.5% by year-end.
Investors now price in no more rate changes this year and a 15% chance of an increase by the middle of next year, according to money-market trading. The median estimate of 30 economists surveyed by agencies is that Trichet will leave rates unchanged throughout 2008. The economists in the survey project fourth-quarter growth in the 13 nations sharing the euro will slow to a 2.1% annual rate from an estimated 2.5% in the third quarter. Some ECB officials still want to keep open the option of raising borrowing costs.
Data last week showed that consumer prices rose at a 2.6% annual rate in October: That was the most in two years, and the second month of increases exceeding the ECB’s aim of “close to, but below” 2%. Prices may climb further as oil sets records over $93 a barrel and the price of food, including milk and wheat, surges.The inflation outlook in the euro region “is subject to upside risks”, Axel Weber, president of Germany’s Bundesbank and a member of the ECB’s governing council, said in an October 30 speech in Giessen, Germany.
Download
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
The Economic Times Business News App for the Latest News in Business, Sensex, Stock Market Updates & More.
Download
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
The Economic Times News App for Quarterly Results, Latest News in ITR, Business, Share Market, Live Sensex News & More.
ADVERTISEMENT
