Despite the euro zone flash estimate pointing to slowing inflation for August, Newedge economist Annalisa Piazza is anticipating that Trichet will highlight that price stability risks were still on the upside and that wage pressures within the euro zone were a cause for concern.

In a research note to clients, Piazza pointed to recent data releases and suggested that wage growth in the third quarter of 2008 could reach 3.1%, adding to the worry that a wage-price spiral could be seen in the near future.

"As such, we expect the ECB to wait for clear signs of decelerating inflation risks before considering the removal of some monetary tightening," Piazza said.

"Recent survey indicators have shown the first signs of easing inflation expectations (both from consumers and companies) and inflation expectations measured by inflation-linked bonds have fallen considerably (5y break-even inflation currently trades at around 2.15% vs 2.8% the first week of July). However, the hawkish tone of ECB officials remained and this is a clear sign that this is not enough."

Piazza also suggested that the central bank's focus would remain on inflation, despite the likely downward revision to its growth projections, both for this year and 2009.

"As highlighted by some of the most hawkish ECB members, the ECB Governing Council is currently more worried about the inflation development rather than growth."

In addition, Piazza speculated that Trichet would repeat that the central bank had no bias towards interest rates. "As such, no change in the ECB policy stance is expected."

Lehman Brothers economist Laurent Bilke agreed. "For the governing council to reverse its stance only a couple of months after a rate hike would be to admit a mistake, which we do not see as very likely," Bilke said, alluding to the central bank having raised its main refinancing rate 25 basis points in July.

"The governing council hiked rates amid fears of 'second-round effects,' and we expect it to continue to overweight this element in its analysis.

Bilke speculated that the central bank would likely see the economic slowdown in the monetary union as a "soft spot" due to commodity price effects which could dissipate towards the end of this year. The Lehman Brothers economist also suggested that Trichet would minimize the impacts of the global economic slowdown, the tightening credit environment and the depreciating euro.

"Regarding monetary developments, we look for an acknowledgment that M3 growth is moderating, but this may be too dovish a signal for the ECB to make at this juncture," Bilke said.

On August 28, the ECB reported that the M3 money supply growth rate slowed to 9.3% in July, down from June's 9.5% rate.

While acknowledging the importance of Trichet's introductory statement, RBC Capital Markets fixed income strategist Richard McGuire stressed the magnitude of the central bank's staff projections, also expected to be released on Thursday.

"The stunted growth profile that we've envisaged stands to provide downside pressure to (the ECB's) inflation forecast," McGuire began. "But, then again, the weakness in the euro should have the opposite effects."

"So, all in all, very uncertain, and it's that number unfortunately that is key for determining whether we are seeing any possible shifts in stance on the part of the ECB from the vantage of the press statement."

However, despite this uncertainty, McGuire emphasized that Trichet would most likely err on the side of hawkishness, especially in light of current wage negotiations going on in Germany, along with strong pipeline pressures seen within the euro zone.

McGuire also stressed that the CPI flash estimate pointing to slowing euro zone inflation should not be taken as a signal that the central bank would now be shifting its focus to growth.

"The key point to bear in mind is, although it does appear for now that the peak of inflation may be behind us, at 3.8%, regional inflation is still around double the ECB's target."

"So, even with inflation coming off, it's clearly too elevated to reassure this particular central bank," McGuire concluded.

By Todd Wailoo, This email address is being protected from spam bots, you need Javascript enabled to view it , edited by Sarah Sussman, This email address is being protected from spam bots, you need Javascript enabled to view it

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