By Jack Duffy
NEW YORK (MNI) – The European Central Bank may signal a pause in
its push to raise interest rates as it confronts a slowdown in economic
growth and a possible worsening of the Eurozone debt crisis.
The central bank is widely expected to leave its main refinancing
rate unchanged at 1.5% at Thursday’s Council meeting, and analysts will
scrutinize President Jean-Claude Trichet’s language for signs that
policy might be on hold even longer.
Investors had expected a third rate increase from the ECB this
year, possibly as soon as October. But rising market turbulence over
debt problems in Europe and the United States and a recent slew of
downbeat economic data now suggest a wait-and-see approach.
“The ECB has room for a pause,” said Nick Kounis, head of macro
economic research at ABN Amro. “The loss of economic momentum has been
greater then they have been factoring in. That means more uncertainty
about the timing of future rate hikes.”
Among signs of waning economic momentum, European Commission’s
economic sentiment indicator dropped in July to its lowest level in
nearly a year, while the manufacturing PMI fell to its lowest level
since 2009.
Fears that slackening growth will make it harder for peripheral
European countries to carry their debt loads have continued to push
rates higher in Italy and Spain, despite the second bailout of Greece
last month. Yields on Italian and Spanish 10-year government bonds
soared above 6% this week as spreads against German bunds widened to
record levels.
“Despite the summit on Greece, the systemic risk of the sovereign
debt crisis remains very much alive,” said Kounis of ABN Amro.
ECB Council members will be also be keenly aware that market
turmoil over the near-default and possible downgrade of U.S. Treasury
debt is almost certain to have negative economic consequences. Even
before the debt-ceiling fiasco, U.S. growth had slowed to a crawl,
rising by less than 1% in the first half of 2011.
Of course, inflation is the overriding driver of ECB policy, and at
Thursday’s press conference Trichet is unlikely to diverge from his
standard rhetoric that the bank’s interest rates aim to assure price
stability in the 17-member euro area as a whole.
Consumer price inflation in the Eurozone eased from 2.7% in June to
2.5% in July — still well above the central bank’s target of close to,
but below 2%.
Should the bank reinforce its credibility by focusing on too high
headline inflation while downplaying the flagging recovery and the
unresolved Eurozone debt crisis? Many analysts say the risks appear to
be too great.
“They have acted quite decisively recently, which gives them the
flexibility to avoid a commitment to a further rate increase now,” said
Peter Chatwell, a rate strategist at Credit Agricole.
Analysts say that in Trichet’s wording of the bank’s economic
assessment, the phase “strong vigilance” on inflation, code for an
imminent rate increase, is expected to be absent. Wording that the bank
is monitoring inflation “very closely” would suggest that a rate hike
remains on the agenda, while a pledge merely to monitor inflation
“closely” might suggest no rate hike is likely for the rest of the year.
For their part, investors appear to be betting that the ECB’s next
rate increase will be later than sooner.
“What the market has done over past three weeks during this phase
of the debt crisis has been to gradually price out expectations of a
rate hike in the near future,” said Norbert Aul, a European rates
strategist RBC Capital Markets.
– New York newsroom (212) 669-6430; Email: jduffy@marketnews.com
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