Wednesday, July 05, 2006

ECB and inflation.

ECB May Toughen Tone on Inflation, Maintain Key Rate (Update1)
July 6 (Bloomberg) -- The European Central Bank will probably keep interest rates unchanged today, and policy makers may toughen their inflation-fighting rhetoric to pave the way for an increase as soon as next month.

ECB policy makers led by Jean-Claude Trichet will probably keep the benchmark rate at 2.75 percent, all but two of the 50 economists in a Bloomberg News survey said. The ECB will announce its decision at 1:45 p.m. in Frankfurt and Trichet will brief reporters at 2:30 p.m.

Investors have raised bets the ECB will step up rate increases to keep faster economic growth and surging oil costs from fueling inflation in the dozen euro nations. Policy makers lifted their key rate by a quarter point in the past three quarters. Producer prices are rising at the fastest in more than five years and unemployment is at the lowest since 2001.

``The ECB will express satisfaction at the outlook for growth but also underscore the risk of inflation and, to a degree, lay the groundwork for the next increase,'' said Kornelius Purps, an economist at HVB Group in Munich. ``I expect Trichet to intensify his hints to make the case for a rate increase.''

Economists at JP Morgan Chase & Co, ABN Amro and Barclays Capital last week said they expected the bank to move faster than they'd anticipated. JP Morgan Chief Economist David Mackie expects the bank to raise its rate to 4 percent by early 2007.

`Upside' Risk

Borrowing costs are rising globally as central banks seek to rein in inflation. In the U.S., the Federal Reserve on June 29 raised its main lending rate for a 17th meeting to 5.25 percent from 5 percent and said further increases depend on future information on growth and inflation. Economists expect the Bank of Japan to raise interest rates next week after keeping them near zero since March 2001 to end deflation in the world's second-largest economy.

Stronger growth is giving the ECB room for further rate increases. The European Commission said June 30 that the euro- region economy is expanding faster than it forecast in the previous month, with risks to the 2.1 percent growth estimate ``tilted to the upside.'' The ECB expects about the same pace this year after a 1.3 percent expansion in 2005.

European manufacturing expanded in June by the most since August 2000 and services grew at the fastest pace in six years. Euro-region unemployment declined in May to the lowest since October 2001, pushing the jobless rate to 7.9 percent.

`Higher Adjustment'

ECB council members have said they're concerned accelerating growth leading to more entrenched inflation as companies pass on higher costs and workers seek more pay.

``I would not rule out a higher adjustment to rates than 25 basis points,'' nor quickening the pace of increases from once every quarter, ECB council member Nicholas Garganas said in an interview on June 26. In another interview the same day, fellow council member Yves Mersch said the bank ``won't hesitate to act'' when needed and that rates are still ``historically low.''

``They have sent a clear message that they want to step up the pace and we will discover the word `vigilant' thrown about with abandon,'' said Charles Diebel, head of European rates strategy at Nomura Holdings Inc. in London. ``The market would take that as a sign they will move at the start of August.''

Trichet last used the word ``vigilant'' to prepare markets for the rate increase on June 8.

Rising Prices

Euro-region inflation held at 2.5 percent in May and credit growth grew at the fastest pace since the bank took charge in 1999. The ECB aims to keep inflation just below 2 percent.

Crude oil prices have increased 26 percent since early December when the ECB raised rates for the first time in 2 1/2 years. Crude touched a record of $75.40 a barrel in New York yesterday and was trading at $74.99 at 8:15 a.m. in Singapore.

Producer-price inflation in the euro region accelerated to the fastest pace in more than five years in May. Excluding energy, prices rose 2.6 percent from a year earlier, up from 2.2 percent in the previous month.

``ECB hawks can credibly claim that growth above trend, inflation above target and a run-away surge in credit justify a faster pace of policy firming,'' said Holger Schmieding, chief economist at Bank of America in London. ``The key risk to our baseline scenario of one 25 basis point rate hike each quarter remains that the ECB may accelerate the pace.''

Investors have increased bets the ECB will raise rates more rapidly. At 3.64 percent on July 5, the yield on the three-month futures contract for December shows investors have now almost fully priced in a further 75 basis points of tightening by the ECB this year, compared with 50 basis points on June 12.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's debut in 1999.


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