ECONOMY

Analysts watching for signs ECB will reverse policy and hike rates

LONDON – Interest rate futures are prepared this week to receive some of the strongest signals yet that the European Central Bank is approaching the end of a two-year stretch of stable rates following a recent sell-off on inflation concerns. In the wake of their recent rout, Euribor futures – a gauge of euro zone interest rate expectations – firmed a shade in profit-taking yesterday but were still pricing in an eventual quarter percentage-point rise in the ECB’s benchmark rate to 2.25 percent. The market is now projecting that the ECB will almost certainly start its monetary tightening cycle by mid-2006, having given just a 30 percent chance of this two weeks ago. It also sees a reasonable risk of a hike as early as March and a strong possibility that two rate rises could be in place by the end of next year. Prices still indicate the ECB will not move rates soon – and definitely not at today’s policy meeting in Athens – but traders were betting that rising inflation, a recovering industrial sector and a weakening currency would prompt President Jean-Claude Trichet to talk tough. «We expect a somewhat more hawkish tone in general because they have all the reasons to be a little bit more upbeat on growth relative to last month when they presented the growth forecasts, which were somewhat more downbeat,» said Christoph Rieger, interest rate strategist at Dresdner Kleinwort Wasserstein. «At the same time we have inflation rising to a long-term high, in the latest flash estimate at least. We have money supply continuing to accelerate and we have the euro also faltering.» The ECB has held its benchmark interest rate at 2 percent for more than two years in a bid to shore up the eurozone’s fragile economy. Last month, the ECB cut its growth forecast to around 1.8 percent for 2006, compared with a 2.0 percent projection three months before. It revised its inflation figure upward to about 2.2 percent for 2005 and 1.9 percent in 2006 from 2 percent and 1.5 percent respectively in the June forecasts. The change in forecasts came at a time when markets were concerned that persistently high oil costs and other economic fallout from hurricanes in the United States could dampen the global economy and cut short the eurozone’s tentative recovery. But investors’ fears for growth have given way to inflation worries. Recent data showed eurozone inflation leapt to 2.5 percent in September from 2.2 percent in August, even further above the ECB’s ceiling of 2 percent. Dealers note that underlying inflation still appears subdued, suggesting that costly energy has yet to spark the «second round» effect of boosting prices throughout the wider economy. But the trading focus has changed to take into account the possibility that the ECB will eventually act to head off growing price pressures. «Higher energy now equals higher inflation and could equal higher second-round inflation, which is what the ECB is very concerned about now,» said a rate futures trader. Focus on phrasing Markets will focus in particular on how the ECB phrases any concerns it may have about gathering inflation pressures, although some traders say the recent sell-off means Trichet will have to be surprisingly hawkish to trigger further losses. One phrase analysts will watch is the ECB’s recent reference to «particular vigilance» regarding upside risks to price stability. Any attempt to toughen that would send a strong signal in favor of hikes, analysts say, and a good reason to dump Euribor futures. Another one to watch is its evaluation of rates being at an «appropriate» level. «The ECB has said that rates are appropriate and this indicates that there is no rate change to be expected for a longer period of time,» said Bob Maes, interest rate strategist at KBC in Brussels. He said dropping the «appropriate» wording in favor of something like «current rates are in line with price stability» would indicate the ECB was more clearly leaning toward a rate hike, although not immediately. «But I think there is a certain risk that they will keep the ‘appropriate’ wording intact and that they will repeat that they are particularly vigilant on the upside risks on inflation,» said Maes, citing subdued underlying inflation. «So in this context this could be somewhat of a disappointment in the market if the ECB sounds not as hawkish as some expect.»

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