ECB: Preview of Today's Meeting

The story is very much the same this month, and we don't expect a big change in the tone from ECB. The market impact should therefore be limited. On the one hand inflation risks are intensifying as oil prices keeps rising. But on the other, downside growth risks are also strengthening and actual data have started to illustrate this. The ECB will continue to warn strongly against second round effects but will hold on to the view that current rates are appropriate to fight inflation risks.

Overview

The inflation pain keeps getting worse in Euroland with the continued rise in oil prices. This is particularly the case when measured in euros as the euro has weakened this time around in tandem with the rise in oil price. If oil prices stay at current levels, the inflation rate will most likely shoot up again and could even approach 4% in late Summer. The ECB is most likely to express concern over this development and once again highlight that the time of elevated inflation could be even more protracted. What's important for the ECB is that it doesn't feed through to wages and it is likely to continue to warn strongly that it will not tolerate second round effects. This is not a big change from the last meetings, however, so the market will probably not react much to this.

On the growth side things have also deteriorated, and this will probably also be expressed in the statement and work as counterweight to the hawkish tone on inflation. We have seen a significant decline in, for example, German ifo and Belgium business confidence. And retail sales data suggest that consumer spending is the worst in 15 years. The further rise in oil prices on top of strong increases in food prices is hurting households. The ECB will have a new loan officer survey (will be released tomorrow) and may comment on this. The survey in US released Monday showed a further tightening of credit standards and we expect to see a similar picture in Euroland.

As we see among Fed members, there seems to be a growing division among central bankers in terms of how serious the inflation problem is perceived. It cannot be ruled out that some members will suggest the possibility of a hike. This would be a change from last meeting and hence could grab the market's attention. This will not show up in the statement, of course, but Trichet will most likely get the question in the Q&A session. Overall, though, we still expect unanimity in holding rates steady.

Market interpretation

We don't expect any big market impact as the statement should balance the rising inflation risks with downside risks to growth. The ECB will talk tough on inflation, but this will not be a surprise for the market.

Danske Bank
http://www.danskebank.com/danskeresearch

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