The European Central Bank is expected to leave interest rates at a seven-year high of 4.25% on Thursday as evidence grows of a sharp drop in eurozone economic growth and inflation hits a fresh record high. The Bank of England’s Monetary Policy Committee meeting is also expected to keep rates at 5.0%, despite overwhelming evidence of a major slowdown in the UK economy.
After raising rates for the first time in a year last month, economists expect the ECB to take a breather and all 85 analysts polled by Reuters expect no change on August 7.
Most predict unchanged benchmark credit costs well into 2009 and a run of weak data has backed expectations that the ECB's next move will be a cut, even though inflation in the 15-nation region hit 4.1% in July, the highest on record.
Many economic indicators are at their lowest levels since 2003, when the eurozone's annual growth rate more than halved to 0.4%, Germany was in recession and interest rates were cut to a record low of 2.0%.
But economists expect ECB President Jean-Claude Trichet to show caution at his news conference following the rate decision, probably repeating the message from July that the ECB has no bias but will do whatever is needed to control inflation.
Over the last month, oil and food prices have eased back and market inflation expectations have stabilised — a welcome sign for the ECB, which aims for inflation of just under 2%.
Governing Council members meet in Frankfurt on Thursday, having formally abandoned the practice in the ECB's early years of holding the August meeting via teleconference.
Soaring energy costs pushed eurozone producer prices to a record 8.0% annual increase in June, data showed on Monday, and both manufacturers and service providers report rising cost pressures.
Euro area central bank sources told Reuters that the ECB would raise rates again if the inflation outlook deteriorated, although others expected inflation to ease in the next few months on the back of cheaper oil.
Slower economic growth should also lessen the potential for workers to demand big wage demands and for firms to raise prices strongly because of the high inflation rate.
HIKE WINDOW CLOSED
Most economists believe the window of opportunity for rate rises has closed, following gloomy data. This has dragged down the euro and sparked fears of economic contraction in the second quarter, and possibly the third as well.
The Reuters poll showed the chance of another rate rise by year-end was just 20%, roughly in line with financial market expectations. In contrast, two in three analysts expected at least one rate cut by the end of 2009.
When Trichet flagged a July rate rise in June — to the shock of most observers — he made clear that some policymakers were reluctant to tighten policy. Economists said winning support for any further tightening would be even tougher due to the economic outlook and financial market tensions.
Benchmark three-month Euribor interest rates hit a 7-1/2 year high on Monday, despite extra measures agreed with the U.S. Federal Reserve and the Swiss National Bank to add extra liquidity to markets.
Eurozone economic sentiment fell to its lowest level in more than five years in July, and consumer and business confidence in major economies is also at record or historic lows. Sentix investor morale fell in August to its lowest since July 2003.
Adding to the gloom, factory and services activity also contracted at the fastest pace seen since 2003, with the manufacturing Purchasing Managers' Index falling to 47.4.
FED ON HOLD
The U.S. Federal Reserve decided to hold interest rates steady on Tuesday, acknowledging financial conditions remain strained, but making clear it is still worried about inflation despite a recent pullback in energy prices.
Economists say the central bank is likely to hold off raising rates until the housing sector is more stable.
While a number of Fed officials have been vocal in arguing about the danger of holding rates too low for too long, recent data have supported a patient monetary policy approach, with falling employment and subdued second-quarter growth underscoring the fragile state of the economy.
Meanwhile, financial firms have continued to wrack up eye-watering subprime mortgage losses. This ongoing pain prompted the Fed last week to confirm that it still considers financial market conditions to be "unusual and exigent" as it prolonged a cash lifeline to investment banks until January.
High headline inflation amid soaring energy and food prices has troubled the Fed's rate-setting Federal Open Market Committee and prompted a series of dissents this year in favour of a tighter policy stance.
In addition, recent data suggest wage pressures are muted.
A report on employment costs on Thursday showed wages and salaries have advanced a moderate 3.2% over the 12 months to June, the same as in the period up to March, while the closely watched jobs report on Friday showed the 12-month change in average hourly earnings holding at 3.4%, the lowest since January 2006.
