Posted on Wednesday, 29th June 2011 by Charlotte W
At today’s meeting the ECB Governing Council left its key policy rate unchanged, signalling, however, that an interest rate hike within one month was likely. The code word “strong vigilance” – which in the past had signalled a rate hike within one month – was included in the communiqué following the two-day meeting. It looks likely therefore that the refi rate will be raised to 1.5% in July.
The tightening cycle looks set to continue. President Trichet stressed that risks to price stability are on the upside. The ECB has raised up its inflation projections for this year and let them unchanged (the mid-point estimate) for 2012 (see table on pdf.).
Despite the moderation in May, (to 2.7% from 2.8% in April), inflation is likely to remain on a upward trend going forward. Firms continue to pass on past price increases in commodities to final prices. Ex food and energy inflation , – i.e. core inflation, which is less volatile and more driven by domestic forces- is also increasing, despite some monthly volatility. Last but not least, ongoing growth in global activity – albeit at somewhat slower pace – will continue to keep oil prices at fairly high levels. Headline inflation will therefore rise over the coming months and could reach and exceed the 3% threshold by year-end, before easing next year.
The Governing Council acknowledged the positive underlying momentum of the eurozone as a whole. GDP growth accelerated to 0.8% q/q in Q1 2011 from 0.3% q/q in the previous quarter. Figures in first quarter were somewhat distorted by temporary factors. Therefore, a moderation going forward is likely. The ECB has revised upward its growth forecasts for this year, leaving almost unchanged projections for next year.
However, the picture for the eurozone as a whole masks deep differences between countries. Core countries, especially Germany, are doing pretty well. Activity in Germany has even come back to pre-crisis level. However, conditions in peripheral countries are extremely different, with activity either showing very low growth or even contracting.
This said, internal divergences will probably affect at least two aspects of ECB monetary policy: the pace of monetary tightening and the exiting of non-conventional lending measures. As regards the first point, it is likely that the ECB will continue to raise rates at a moderate pace. An interest rate hike is likely to be more damaging for peripheral countries than for core countries. Spain and Portugal, for instance are among the countries with the most negative exposure to the ECB’s monetary tightening cycle, since almost all their mortgages have variable rates and are indexed to
Euribor.
Further withdrawal of non-standard lending measures has been postponed
The ECB will continue to support the peripheral economies through its non-standard lending measures. Today the Bank decided to continue to conduct all its refinancing operations with full allotment at least until the end of Q3. The ECB is currently allotting more than 60% of its liquidity to Greece, Portugal, Spain and Ireland, whereas these economies amount to only 16% of the Eurozone GDP.
Lastly, regarding Greece, the ECB reaffirmed its position: the Bank will exclude any agreement that could trigger a “credit event” such as debt reprofiling or restructuring and, of course, default. The ECB will favour the involvement of the private sector which is only strictly voluntary.
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Tags: Ecb, Ecb Tightening
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