Highlights:
- ECB signals rate hike next month, but attempts to keep some ‘wriggle room’.
- Less hawkish tone of ECB comments and non-threatening forecasts make markets less fearful about extent and pace tightening further out.
- Uncertainty about Greece clearly argues against comments or action that might unnerve markets.
- ECB rates may not reach 2% until early 2012 but markets may be too complacent in this view.
- Weak Irish inflation suggests ‘real’ rates much higher here than elsewhere in the Eurozone.
As expected, ECB President Jean Claude Trichet today signalled an intention to raise official interest rates at the ECB’s next policy meeting on July 7. Mr Trichet did repeat the usual mantra that the ECB never pre-commits at today’s press conference and said had a decision been taken today to raise rates in a month’s time that he would have said this explicitly. However, these comments are only intended to provide the ECB with some ‘wriggle room’ should there be an explosive deterioration in financial market conditions. By including in today’s opening press statement the well established code words ‘strong vigilance is warranted’, the ECB indicated a clear intention to raise its key policy rates next month in the absence of a severe escalation in financial market strains.
Market reaction surprisingly strong
The most notable feature of today’s ECB press conference was the market’s reaction to a number of subtle, minor changes that reduced concerns that an aggressive sequence of rate increases might lie ahead. It seems very clear that the ECB wanted to engineer a calm market response to today’s comments. Mr Trichet made determined efforts to avoid providing any guidance on how ECB policy might change after July. In this regard, he indicated that he was ‘not signalling any particular pace for the next decisions’. It remains the case that further rate rises lie ahead, but as Mario Draghi, Mr Trichet’s successor-in-waiting, noted earlier this week significant uncertainty at present ‘warrants an element of gradualism in changing standard and non-standard measures’.
New Staff projections: no big surprises
A sense that the ECB is not poised to raise rates aggressively would also be consistent with the picture emerging from the new ECB economic projections released today. As expected, the midpoint of the inflation forecast for 2011 has been raised from 2.3% to 2.6%. However, the forecast for 2012 has been left unchanged at 1.7%. Strictly speaking, this may hint at a slight deterioration in inflation trends next year compared to the previous projection because the comparison with rapidly rising inflation in 2011 might be expected to produce an easing in measured inflation in 2012.However, markets appear to have expected that the ECB would signal significant inflation concerns by nudging up the inflation projection for 2012 as well as 2011. Significantly, today’s ECB press statement added a comforting interpretation of the new projections by indicating ‘overall, the projections embody the view that the recent high rates of inflation do not lead to broader-based inflationary pressures in the Euro area’.
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