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European Central Bank holds rates steady

European Central Bank President Jean-Claude Trichet strengthened his anti-inflation message on Thursday, saying the ECB would monitor prices "very closely", a sign that it may raise interest rates in March.
/ Source: Reuters

European Central Bank President Jean-Claude Trichet strengthened his anti-inflation message on Thursday, saying the ECB would monitor prices "very closely", a sign that it may raise interest rates in March.

The ECB was ready to increase rates when needed, Trichet said after the bank's Governing Council left borrowing costs at 2.25 percent following December's quarter percentage point rise.

However, he gave no hint that a rate rise would come next month, which some analysts had thought possible due to a strengthening euro zone economy. While Trichet welcomed the improved growth outlook, he noted that downside risks persist.

"Everybody knows we act when necessary. We have demonstrated that recently. That is well understood by observers and certainly by market participants," he told a news conference.

"We will continue to monitor very closely all the developments with respect to risks to price stability over the medium term," Trichet said -- a shift in emphasis from December when he simply said the ECB would monitor prices "closely".

Analysts said this bolstered expectations the ECB may raise interest rates by 0.25 percentage points by the end of March. "It's a slight hardening in the language, but just marginal," said Lorenzo Codogno, senior economist at Bank of America.

"There's no clear indication that they're going to move in February, so we stick to our view that the next move will be in March."

The euro currency initially sank against the dollar on the less hawkish than expected ECB language.

Euribor futures were still close to fully pricing in another quarter point increase for March, but the growth risk comments took a sizeable bite out of betting on a potential move in February.

The March Euribor contracts were up 2 basis points to 97.320, and June contracts were up 2.5 basis points to 97.155 from before the ECB rate decision.

Rate sensitive two-year bond yields were little changed at 2.825 percent.

Growth better
Trichet painted a more complex picture on growth. The economic environment was becoming steadily better, yet there was still a risk that growth could disappoint.

"Risks to this outlook for economic growth continue to lie on the downside and relate to high and volatile oil prices, concerns about global imbalances and the level of consumer confidence in the euro area, although the latter is improving."

Yet he noted that recent data and surveys confirm the ECB's view that the 12-nation euro zone is steadily heading toward its potential growth rate, Trichet said. The mid-point of the ECB's 2006 growth forecast is 1.9 percent, while potential is estimated a little over 2 percent.

Euro zone monetary policy remained accommodative, and M3 money supply growth was very robust, he added.

Investor sentiment in Germany, the biggest euro zone economy, surged to a two-year high in January, according to Tuesday's ZEW index. This capped a run of broadly positive data from across the 12-nation currency bloc.

But German GDP gave a less clear signal, rising 0.9 percent in 2005, down from 1.6 a year earlier. The German Statistics Office saw no growth in the fourth quarter from the third.

However, the outlook is brighter for the region as a whole. The euro zone Purchasing Managers' Index showed the manufacturing sector expanding at its fastest pace since August 2004 and services growing at the fastest for almost two years.

Consumer price inflation fell for a third month running, to 2.2 percent, though this remains above the ECB's target of a rate below but close to 2 percent. Moreover, money and credit growth is still strong, raising the risk of inflation pressures in the future.

As a result, current euro zone interest rates are barely positive when adjusted for inflation, representing cheap credit conditions when the economy is picking up.