NBG projects series of ECB rate hikes to 3.25 pct by 2007

The European Central Bank (ECB) will continue raising its key rates in 2006 and 2007, at the end of which it will stand at 3.25 percent from 2.25 percent today, the National Bank of Greece (NBG) projected in a report yesterday. Still, NBG said that the ECB’s recent rise of 25 basis points (bps) may have been rather premature, as the sustainability of a strong recovery in Europe has not yet been confirmed. The report foresees that the ECB’s key rate will be raised by 25 bps in March and by an equal measure in September 2006, with two further increases in 2007. The crucial question, according to NBG, is whether, after the first hike in its basic rate in five years, the ECB has initiated a cycle of restrictive monetary policy with a view to approaching the «neutral level» of 4 percent, or whether the recent rise was an isolated move. «The restrictive policy scenario is supported by the fact that inflation appears to be going up (with prices rising 2.4 percent in November, against an average of 2.1 percent in the first half of the year), pulling inflationary expectations in the same direction,» said the report. The alternative scenario, of an isolated rise, is based on the fact that the basic macroeconomic indicators suggest only mild inflationary pressures, as core inflation in October remained stable at 1.5 percent (against the ECB’s target of 2 percent). The report argues that the accelerated rise in November, which points to stronger inflation pressures, mainly reflects the influence of two transient factors – the increase in crude oil prices and the slide in the parity of the euro. «Higher oil prices are already reflected in inflation… Let it be noted that the rise in the price of energy, which consumers ultimately pay, is much smaller than the rise in the price of crude (by about 80 percent), as a large part of it represents taxes,» NBG said. Nevertheless, the authors of the report consider that in view of the fact that monetary policy influences growth about 18 months later, and that interest rates are about 200 bps below the levels associated with a neutral monetary policy, «the ECB has reasonably begun gradually raising its intervention rates.» NBG projects that the eurozone’s growth rate will accelerate to about 2.3 percent in 2007, while wage demands will raise the unit labor costs by about 1.5 percent, pushing inflation to 2.0 percent and core inflation to 1.8 percent. Banks bearing gifts The insecurity created among borrowers by the likelihood of further key rate hikes by the ECB presents new opportunities for banks, which have already begun announcing lower variable rate loans aimed at attracting new borrowers but also enticing those who have already borrowed at variable rates to convert them into fixed-rate loans. Such a conversion involves significant commission charges and a long-term commitment on the part of borrowers which is too costly to reverse.