ECB less hawkish, back to neutral bias

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says Citi

The ECB increased, as widely expected, the official rates by 25 BP after Thursday’s meeting. As a result, the upcoming weekly refi operations, settled on July 9, will be conducted at a minimum bid rate of 4.25%.

The post-meeting statement was less hawkish than Citi analysts expected. The statement did not repeat that the governing council would be in a “state of heightened alertness” and that they would be “acting in a firm and timely manner” to prevent second round effects.

President Jean Claude Trichet said that after today’s hike, interest rates would “contribute to achieving our (ECB’s) price stability objective” and clarified in the Q&A session that the ECB would have no bias at the moment. The statement repeated the ECB’s strong determination to anchor long- and medium-term inflation expectations and that the ECB would monitor all developments very closely. What was new in the opening statement according to Citi, and probably responding to the broad-based criticism before the rate hike, was the reference that price stability shall “preserve purchasing power in the medium term and continue to support sustainable growth and employment in the euro area.”

After some ECB representatives had suggested that there already would be second round effects from the current high inflation rates, the statement just continued to warn about the risk of these effects. The ECB still has a favourable view on economic growth saying that the “fundamentals of the euro area economy remain sound” but highlighted also the downside risks to growth. In its monetary analysis the ECB concluded that ongoing strong underlying money and credit growth still signal upside risks to medium term price stability. Here again, the ECB expressed some more uncertainty regarding the negative impact of the financial market turbulence on bank lending.

In summary, 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. Citi economists 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.