ECB hawkish on inflation
European Central Bank President Jean-Claude Trichet stepped up his anti-inflation rhetoric yesterday, saying strong vigilance against renewed oil price pressures is essential. Trichet said the ECB’s Governing Council had discussed raising interest rates but decided to leave them at 2 percent, saying this level remained appropriate. But he stressed the dangers of «second-round effects,» in which surging energy costs can feed into the overall eurozone inflation rate. Eurozone rates have been steady since June 2003 in order to shore up economic recovery, but recent high oil prices, fast money supply growth and rising inflation have clouded the price stability outlook. «We have an absolute need to be strongly vigilant as regards second-round effects which can be lasting and our worst enemy,» Trichet said after the ECB council met in Athens, one of two meetings a year held away from its Frankfurt headquarters. This represents a hardening of Trichet’s position since September, when he said «particular vigilance» on price pressures was needed. Trichet said he was not giving early warning of an interest rate rise, but that the ECB was ready to raise rates at any time if the economic situation made it necessary. «I am not preannouncing an interest rate increase. But we are considering all elements we have… and risks to price stability are on the upside,» he said. Asked if the council had discussed raising rates, Trichet said: «Yes, certainly. (We discussed) the pros of not moving (and) the pros and cons of raising interest rates.» Wage growth in some countries was a concern, though domestic price pressures remain contained overall, Trichet said. Economic growth could gradually pick up over the rest of the year, supported by global demand, he added, striking a similar tone to last month. Debt futures retreat Economists and markets had expected Trichet to toughen his anti-inflation stance while keeping rates on hold, and December Bund futures and June Euribor contracts reversed earlier gains made on the back of US Treasuries. The Bank of England had earlier also kept rates steady at 4.50 percent. «The market has turned around and lost the gains because Trichet emphasized the strong vigilance required and sounded more hawkish,» said Bob Maes, a fixed income strategist with KBC in Brussels. Joerg Kraemer, an economist with HVB in Munich, agreed that Trichet was significantly more hawkish, but said a rate rise was still not likely soon. «We don’t believe the ECB will hike this year because second-round effects are still not visible. Discussion about rate hikes will increase, but in the end the ECB is unlikely to hike rates,» he said. Hawkish tilt The ECB faces the dilemma of balancing inflation risks against a growth outlook that is still far from solid. The manufacturing and service sectors are showing surprising vigor and business confidence has strengthened the past month, despite persistently high crude oil prices and political uncertainty in the eurozone’s largest economy, Germany. Nonetheless, German industrial orders posted a fall in August, according to fresh data yesterday, although analysts said the economy remained on track for a third-quarter recovery. The European Commission also cut its 2005 eurozone growth forecast to 1.2 percent, near the ECB’s 1.3 percent estimate, noting short-term risks to growth from high oil prices. The inflation outlook has deteriorated too. Consumer prices rose at a 2.5 percent annual rate in September and money supply surged in August, while inflation expectations in surveys and market indicators have risen the past three months. Cheap imports are also under threat now the euro is trading around $1.20, down from over $1.25 a month ago. The interest rate futures market had been braced for a more hawkish tilt. Only two weeks ago, Euribor traders saw just a 30 percent chance of an ECB rate tightening by mid 2006, yet on Wednesday it was projecting a near certainty that steady interest rates will end by June next year. Fazio under scrutiny Trichet also said the ECB welcomed many of the changes the Italian government had proposed to legislation governing the country’s central bank. Reforms to the Bank of Italy were drawn up when disputes mounted in the Italian government over central bank governor Antonio Fazio’s role in a bank takeover fight. Critics charge he tried to thwart a Dutch bid for an Italian bank in favor of a family friend, and Italian prosecutors have opened a criminal investigation into Fazio. The reforms would limit the term for the next governor to seven years from the current life appointment, ensure that banks which the central bank regulates do not hold a controlling stake in it, and require a governor to consult fellow directors more. Trichet declined to comment on this investigation, and would not say whether he was satisfied with the explanation Fazio had given of his conduct.
