ECB hikes

ECB hikes key rate to 4.25%
'No bias' on future rate moves, says ECB's Trichet
By William L. Watts, MarketWatch
Last update: 11:50 a.m. EDT July 3, 2008

LONDON (MarketWatch) -- The European Central Bank returned to a wait-and-see mode on monetary policy Thursday, but only after making good on a threat to hike rates for the first time in 13 months in an effort to wrestle down surging inflation pressures.
"Starting from here, I have no bias" on interest rates, ECB President Jean-Claude Trichet told reporters at his monthly news conference following the central bank's widely-anticipated decision to hike its key lending rate by 25 basis points, or a quarter of a percentage point, to 4.25%.

'Starting from here, I have no bias.'
— Jean-Claude Trichet, ECB

Financial markets had previously factored in expectations that Thursday's move would be the first in a series of hikes. But economists said Trichet's remarks indicated that the ECB is content to see how inflationary pressures develop as it wrestles with surging prices and signs that growth across the 15-nation euro zone is headed for a significant slowdown.
Trichet, who issued a clear warning in June about the possibility of a July rate hike, used none of the phrases employed in the past to signal another move was imminent.

Key phrases
Asked about the lack of language highlighting either "heightened alertness" or "strong vigilance" on inflation pressures, Trichet would say only that the ECB's message was clear and that the governing council would strive to communicate with the markets in "a clear fashion that will allow us to be as predictable in the future as we have been in the past."

The lack of such phrases - used in the past to flag rate hikes - indicates "no further interest rate hikes are currently planned in the near term at the very least," said Howard Archer, chief U.K. and European economist at Global Insight.

Instead, the language signals that the "the ECB is back in a neutral position for now and will take into account all new information regarding the outlook for inflation and economic growth," said Juergen Michels, an economist with Citigroup, in a research note.

"We continue to expect that deteriorating economic confidence and financial market data will offset more negative inflation news in coming news months, and thus expect rates to be unchanged. However, a further rate hike in coming months is not ruled out," Michels said.
Indeed, Trichet did warn that the ECB remains worried about the potential for surging food and fuel costs to feed through to other prices, particularly through wage- and price-setting.
The ECB governing council "is monitoring price-setting behavior and wage negotiations in the euro area with particular attention," he said.

Thursday's rate hike came after Trichet repeatedly expressed fears that commodity-led inflation pressures could feed into a wage-price spiral. After June's policy meeting, Trichet said the governing council was in a state of "heightened alertness," and that a small July rate rise was possible.

Euro retreats
The euro fell sharply in the wake of Thursday's remarks after pushing above the $1.59 level against the dollar ahead of the rate move. Traders had said it would have taken a decidedly hawkish tone by Trichet to allow the euro to test its all-time high above $1.60.
The euro is 1.2% lower on the day at $1.5705. See full story.

European Central Bank President Jean-Claude Trichet answers questions by WSJ reporter Joellen Perry on current monetary policies. (July 3)European government bonds rallied as markets scaled back expectations for further rate hikes, sending down yields, particularly at the two-year area, which is more sensitive to official rate expectations. The 10-year German government bund yield was down around eight basis points to 4.56%, while the two-year was off around 17 basis points to 4.47%.

The news also helped lift European stocks, with the pan-European Dow Jones Stoxx 600 index (ST:SXXP: news, chart, profile) erasing earlier losses to finish 0.9% higher. See full story.
The rate hike comes as the ECB and other central banks grapple with the monetary-policy dilemma posed by surging inflation pressures and a slowing economy.

In a separate move earlier Thursday, Sweden's Riksbank hiked its repo rate by a quarter point to 4.5% and indicated two more hikes are likely before the end of the year in an effort to push inflation back toward its target range.

Trichet never softened his hawkish tone ahead of Thursday's meeting despite growing evidence that the 15-nation euro-zone economy was showing signs of a potentially significant slowdown, particularly across Spain, Italy and the southern euro zone, as well as Ireland.
Earlier Thursday, the June purchasing managers index for the euro-zone service sector pointed to a contraction. The headline index fell to 49.1 from 50.6 in May, slipping from a preliminary reading of 49.5 and from April's 50.6.

The move below 50 signals that purchasing managers believe the sector, which makes up around three quarter of the euro-zone economy, saw a contraction in activity. A reading of more than 50 indicates growth.

The breakdown of data by country underscored divergence across the euro zone, with readings from Germany and France remaining above the 50 level, while Italy, Spain and Ireland remained mired below the key dividing line.

The data, along with falling manufacturing sector PMIs, declining measures of business and consumer sentiment, and other data, underline expectations the euro zone's solid first-quarter performance will slow significantly into the second half of the year.
Trichet acknowledged a weakening growth outlook for the euro area, but said the region's fundamentals remain sound.

Meanwhile, the ECB's sole mandate is to ensure price stability. And economists said a surge in annual consumer inflation to 4% in June - more than double the ECB's target rate of just below 2% -- sealed the case for Thursday's rate hike.
William L. Watts is a reporter for MarketWatch in London.

ECB signaled today that the Eurozone will be slowing soon. Trichet is expecting slowing economy to cool inflation. That has been predicted by several pundits including Nouriel Roubini who I respect greatly. I am still convinced that as long as a weak dollar policy remains in place or the Bretton II agreement is re-worked worldwide stagflation has a stronger chance than slowing inflation and growth.