ECB May Keep Rates at 7-Year High


The European Central Bank will probably keep interest rates at a seven-year high this week, and may even threaten to raise them, at the risk of prolonging the economic slump.

Policy makers Axel Weber and Lucas Papademos said last week the ECB remains focused on inflation risks and may need to lift rates again if they intensify. Executive Board members Lorenzo Bini Smaghi and Juergen Stark also stepped up their inflation- fighting rhetoric, just days before they meet to decide on rates.

Some investors started betting on a rate cut by early next year after ECB President Jean-Claude Trichet said on Aug. 7 that economic growth would be ``particularly weak'' through the third quarter. Last week, a rate reduction was fully priced in by May, Eonia swap contracts showed. The yield jumped back up to 4.13 percent after Weber and Papademos spoke.

The ECB raised rates in July to prevent a wage-price spiral after inflation accelerated to 4 percent, twice its 2 percent limit. Since then, data showed Europe's economy contracted 0.2 percent in the second quarter and economic confidence has plunged. At the same time, a 20 percent drop in oil prices has slowed inflation to 3.8 percent.

Trichet will on Sept. 4 unveil new economic forecasts that are likely to revise down the growth assessment and ratchet up the outlook for inflation, said Elga Bartsch, an economist at Morgan Stanley in London.

In June, ECB staff projected growth would slow to about 1.8 percent this year and 1.5 percent in 2009 from 2.7 percent in 2007. Inflation was forecast to average 3.4 percent this year and 2.4 percent in 2009.

Wage inflation is accelerating across Europe as workers seek compensation for higher food and energy costs. IG Metall, Germany's biggest union whose wage accords cover 3.2 million workers, will present this year's claim on Sept. 8. It has said it will demand a bigger pay increase than the 6.5 percent it asked for last year.


TradingEconomics.com, Bloomberg.com
9/1/2008 6:44:00 AM