Advice on rate hikes

SINGAPORE – The European Central Bank (ECB) needs to proceed with caution on interest rate rises in the euro currency zone, even if it is right to want to tighten the cost of borrowing to head off inflation, the IMF’s top economist on Europe said yesterday. In an interview with Reuters, the IMF’s Michael Deppler urged the ECB to play things by ear, highlighting that the International Monetary Fund still believed inflation, and notably wages, remained well-contained. «There is ample time for the ECB to adjust to the situation. So our basic line is that a cautious pace of tightening is the appropriate stance to take,» Deppler said. «Basically, take it step by step.» The ECB started increasing interest rates in December, when they stood at a historical low of 2.0 percent. Its latest hike in August brought the key rate to 3.0 percent and financial markets are betting on a policy rate of about 3.5 percent at year-end. Deppler acknowledged that the IMF, like most others, had not foreseen the strength of the rebound in eurozone growth in the first half of 2006 and that it had just reversed its stance to endorse ECB rate rises now that confirmation of the upswing had emerged. «As the ECB likes to say, and properly so, one’s views on this are always data-dependent,» he said. «We changed our mind – what our basic assessments of the risks were – when we saw the data,» he said, referring primarily to figures on second-quarter growth and revised first-quarter data that were published only in mid-August. «Looking forward, we don’t see any big internal inflationary pressures from wages, labor costs,» he said. In its World Economic Outlook, published yesterday, the IMF increased its growth forecast for the eurozone in 2006 by nearly half a point to 2.4 percent and predicted growth of a slightly slower 2.0 percent in 2007. That follows a 1.3 percent rise in gross domestic product in 2005 and an annualized growth rate of 3.6 percent in the second quarter, which was the best quarterly rate in six years – and perhaps as good as it can get in most economists’ opinion. Deppler declined to suggest a precise marker for what would be the right level of ECB rates, saying only that the best tack now was a cautious one, moving according to developments. «The pace at which you do so (raise rates) ought to be a function of what the data on the ground show.» Asked if that meant waiting for third-quarter GDP, he said that «may be a bit long» and that there were economic reports other than national accounts that could be used to gauge things. Recoveries had died in their infancy in the past, even if the latest spurt looked like the start of something more lasting. «This is the third upswing in as many years,» the IMF’s Deppler said.