Despite suggestions that weakening economic growth and inflation peaked in July, markets and economists have no illusions about any easing in monetary policy from the European Central Bank at its rate decision on Thursday.Although economists are unanimous in their expectations for the ECB to hold the marginal lending rate unchanged a 4.25%, an implied market forecast according to the EONIA curve sees an 8% chance of a 25bp hike on Thursday and a 46% chance of a 25bp cut by March.
“The leaders of the European Central Bank (ECB) will also opt for maintaining the status quo, keeping the key interest rate at 4.25% in September,” according to a report from Desjardins. “The hope that the Euroland economy would be able to dodge any serious trouble due to the global economic slowdown evaporated in the past few months.”
Inflation remains a serious concern for the ECB, whose hands may be tied for several more months.
Some may suggest that inflation pressures in the region may have peaked in July after the Eurostat flash estimate suggested an inflation rate of 3.8% in August versus the 4.1% rate reported previously. However, economists are quick to point out that price growth has to come down substantially before the central bank can consider the inflation threat over.
“The drop in oil prices since early July has helped ease pricing pressures somewhat. However, inflation and inflationary expectations are still uncomfortably high for the ECB,” said Clemente De Lucia of BNP Paribas. “Therefore, even though inflation is expected to ease, albeit gradually, in the coming months, the ECB will probably maintain the refi rate unchanged at 4.25% for a prolonged period.”
In addition, ongoing wage negotiations with key unions have the ECB’s hands tied if it wants to prevent second-round inflation effects resulting from wages.
“With inflation still relatively elevated this autumn, and with the key IG Metall settlement not due until November, we do not expect that the ECB will have much scope to ease policy this year, though a rate cut in December is a small possibility,” according to Julian Callow and Nick Matthews at Barclays. “In our view, in Q1 09 there will be a ‘window’ for looser ECB policy, in that we do not expect the Fed to take its first step towards interest rate normalisation until its mid-March meeting.”
To reinforce the point, after several weeks of near silence, a flurry of hawkish talk from various governing council members speaking just one week prior to the meeting was considered by many to be a wake-up call for any believing the central bank could be swayed by weaker growth statistics.
“The hawkish choice of words of Weber (and other ECB representatives such as Papademos and Bini Smaghi) may also have been intended to counter rate-cutting speculation as reflected in the decline in the forward rates for the 1M Eonia swap rate,” explained Dr. Jens-Oliver Niklasch at Landesbank Baden-W?rttemberg.
Consequently, all eyes and ears will be focused on comments from President Jean-Claude Trichet when he delivers his press conference 45 minutes following the announcement.
“We reckon that Jean-Claude Trichet will adopt much the same tone as at the previous meeting,” said S?ren Dijohn, analyst at Danske Bank. “His starting point will be the latest ECB Staff projection, which we expect to include a downward revision of growth both this year (down from 1.8% in the June forecast to 1.4%) and next year (down from 1.5% to 1-1?%).”
