Euroland: ECB in a State of Heightened Alert
Overview:
The ECB has kept rates unchanged but the statement was very hawkish compared to last time. This is the closest that the ECB can come to saying "vigilant" (and hence preparing for a hike).
Mr Trichet mentioned several times that the ECB was "in a state of heightened alertness", and stated that although the decision to leave rates unchanged in the end was unanimous, the board members had differing views.
Details:
The ECB is "in a state of heightened alertness", as risks to price stability over the medium term have increased further. This is reflected in the ECB staff projections for inflation, which have been raised markedly for both 2008 and 2009. In 2009, inflation is projected to be in the interval of 1.8%-3.0%, and is thus likely to stay above 2.0% throughout 2009. Mr Trichet stressed that the ECB would prevent second-round effects and ensure that risks to price stability over the medium term do not materialise by acting in a firm and timely manner.
Concerning economic growth, Mr Trichet mentioned that the new staff projection for 2008 (1.5%-2.1%) was at the upper end of the interval in the March projection and that the 2009 forecast had been lowered (to 1%-2%). Growth is projected to weaken in 2008 before accelerating gradually over the course of 2009.
Whether the ECB chooses to hike in the coming months is a close call. It was a unanimous decision to leave rates unchanged for the moment. However, in the question session, Mr Trichet spoke very frankly about the exchange of opinions leading up to the decision to keep rates unchanged for now. He mentioned that a number of governing board members were in favour of a hike now, a number were in favour of a hike but not now, and some were against a hike.
Assessment and outlook:
The possibility of a hike has increased significantly - but it is a possibility only. Markets are expecting a hike in July/August. By making such a strong statement and the following market reaction, one can argue that not much is gained by the ECB if it does not raise rates. However, even if the ECB hikes we do not think that it will raise rates by 75 bp, as the markets are currently pricing.
In light of the strong statement, we are considering changing our rates outlook. We are in unchartered territory. The board members' very different views on the necessary rate policy, among other things, reflect this.
What does it take for the ECB not to hike rates? In our view, it takes either a significant decline in oil prices or very clear-cut signals of a strong deterioration of the growth outlook (relative to the staff projections) eg, a very marked drop in the ifo. Until now, the ifo has not declined as sharply as many other indicators on the economic situation, so there may be something in store.
Danske Bank
http://www.danskebank.com/danskeresearch
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