ECB chief expected to maintain anti-inflation tone
By William L. Watts, MarketWatch
LONDON (MarketWatch) — The European Central Bank left its key lending rate unchanged at a record low 1% on Thursday, offering no surprises and leaving investors to focus on ECB President Jean-Claude Trichet’s monthly news conference amid rising inflation concerns.
Since Trichet’s Jan. 13 news conference, financial markets have priced in a rising chance of a rate hike as early as this summer, compared to earlier expectations for a move in late 2011 or early 2012. The shift came after the ECB chief warned that the central bank was keeping a close eye on inflation pressures and reiterated the ECB’s focus on price stability.
Trichet’s February news conference is scheduled to begin at 2:30 p.m. Frankfurt time, or 8:30 a.m. Eastern.
A further move in consumer inflation above the ECB’s target of near but just below 2% in January also contributed. Inflation edged up to an annual rate of 2.4%, according to a preliminary estimate by the European Union statistics agency Eurostat.
Trichet’s January news conference helped kickstart a sharp euro rebound, which took the single currency to its highest level versus the dollar in nearly three months this week. The single currency (EURUSD 1.3758, -0.0047, -0.3404%) traded at $1.3768 in recent action, a loss of 0.3% from Wednesday.
Some strategists contend markets may have been overly aggressive in pricing in hikes, noting that core inflation, which excludes food and energy prices, still appears subdued and well below the ECB’s target.
Subsequent remarks by ECB officials, meanwhile, indicate the central bank is for now willing to look beyond the current food- and energy-related hump in inflation, but will be on the lookout for any significant rise in core inflation pressures, said Elwin de Groot, economist at Rabobank in Utrecht, Netherlands.
“We think the market has got carried away a bit with the idea that the ECB will raise its benchmark rate before summer. In our view, the list of uncertainties is just too extensive at the moment and we doubt these uncertainties will have been completely removed come July,” he said.
Austrian central bank chief Ewald Nowotny last month indicated he felt no need for a near-term rate move, economists noted. ECB executive board member Juergen Stark last week said there were no indications of worrisome medium-term inflation pressures, de Groot noted.
Meanwhile, the euro zone’s sovereign debt crisis has yet to be resolved, although yield premiums demanded by investors to hold peripheral euro-zone debt over benchmark German bonds has narrowed sharply in recent days on news reports that European officials are moving toward agreement on revamping the European Union’s portion of the euro-zone rescue fund, known as the European Financial Stability Facility.
European leaders are expected to agree on a broad outline of a plan when they meet Friday, news reports said.
Trichet will also be watched for indications or hints that the ECB is looking to further cut use of its liquidity facilities by troubled euro-zone banks that have struggled to meet funding needs in the interbank market. News reports have floated the possibility the ECB will eventually move to put a premium on top of the fixed rate for excessive borrowers.
“An important risk for the foreign-exchange markets to consider is whether or not the ECB is on the verge of accelerating its move towards more normal money market conditions,” said Stephen Gallo, head of market analysis at Schneider Foreign Exchange, in a note to clients.
Economic activity has also surpassed expectations in the euro zone. The composite purchasing managers index for the region rose to 57.0 in January, up from 55.5 in December, and the strongest reading since August 2007. That would translate into first-quarter euro-zone GDP growth of around 0.8% compared to the previous quarter, according to Barclays Capital.
With both inflation and activity data topping expectations, “there appears little reason to expect ECB President Trichet to soften the more hawkish tone adopted at last month’s ECB press conference when he speaks later today," said Simon Smith, chief economist at FxPro, in a research note.
But while Germany and other core nations are booming, higher rates won’t be welcome in the periphery, where employment remains well below the pre-crisis peak, he noted.
“Slower inflation in the periphery (versus the core) is one of the remedies for some of the lost competitiveness (in the absence of exchange rate devaluation),” Smith wrote. “The alternative is to allow slightly higher inflation in the core, but the likelihood of that happening is small and diminishing as the end of Trichet’s tenure approaches” in October.
