Tuesday, June 5, 2007

Central Bank Watch - ECB and Bank of England

ECB (June 6)
There is little doubt but that the ECB will hike rates for an eight time in 18 months, when they meet this Wednesday, to bring the euro zone’s base rate to 4%. The real issue concerning markets is what will happen to euro rates thereafter. The ECB’s Weber was quoted last week as having said the ECB would refrain from using code words to signal future rate hikes, so we expect a new approach from Jean Claude Trichet in his post announcement press conference this week. Economic data from the eurozone is holding up positively, despite the recent rate rises, so the Bank could justify continuing a hawkish line if it so chooses. It is likely that no further rate hike is on the agenda until at least September, so the ECB may decide to kick the issue to touch and adopt a ‘data dependent’ wait and see approach over the coming months. The MPC will justifiably feel vindicated by their policy strategy as the euro area economy continues to grow impressively, while inflation has firmly been held below 2% since last summer. The most likely outcome Wednesday, is for a hawkish Trichet to keep markets guessing, but appearing hawkish enough for markets to price in one more rate hike after this week. Anything short of a stern warning on price stability/inflation will be perceived as a softening in stance and if the MPC are seen to be backing off, then the euro could be in for a prolonged retreat over the summer months.

BoE (June 7)
Last month’s MPC minutes sent the market into a tizzy, with the unanimous 9-0 vote for May’s hike seen as a slant towards further tightening, possibly as soon as this month. Sterling has advanced on the increased rate prospects but the reality is that the Bank is almost certain to keep rates on hold this week and issue no statement on their deliberation Thursday, thus keeping markets guessing and most likely sending sterling backwards. The Bank will however have sight of May’s CPI data (not published officially until June 12) and if this reveals an inflation climb to over the 3% rate from last month’s 2.8% rate, there remains a remote outside chance of a hike this week. The minutes from the Bank’s last meeting reveal an MPC who are as unsure as to the direction of inflation and thus interest rates as the rest of us. Mervyn King, and by association the MPC, keeps referring to market expectations for where interest rates will be at later this year - in effect telling us the MPC does not have a consensus opinion of its own. The smart money is for one more rate hike, probably in August, but with UK data very much mixed of late, the prospect of no further UK interest rate hikes is also beginning to become a possibility. With the MPC unable to offer any intelligent insight, it is left to the market’s own devices to interpret the economic data as it is released, and what it may mean for interest rates going forward. The first instalment in this regard is not due until next week, when May’s consumer price data is released.