The European Central Bank said in its Monthly Bulletin that was published today, it will raise interest rates further to contain inflation if the eurozone economy develops as it expects.
If the ECB's ``assumptions and baseline scenario are confirmed, a progressive withdrawal of monetary accommodation will be warranted,'' the Bank said. Borrowing costs ``remain low'' even after the ECB raised its benchmark refinancing rate to 3 percent last week, the fourth increase in eight months.
The Bank is worried that inflation will pick-up as economic growth accelerates and wage pressures increase. Inflation was 2.5 percent in July, keeping it above the ECB's limit of just below 2 percent for an 18th consecutive month.
``In the second half of 2006 and on average in 2007, inflation rates are likely to remain above 2 percent,'' the ECB says. ``Risks to the outlook for price developments have augmented'' and include ``stronger than expected wage and price developments owing to second-round effects of past oil price increases.''
A survey of professional forecasters by the ECB shows analysts have raised their expectation for inflation this year to 2.3 percent from a forecast of 2.1 percent published in May. Inflation may slow to 1.9 percent in 2008, the survey shows. ECB raised their growth projection for 2006 to 2.2 percent from 2.1 percent. They reduced their 2007 estimate to 1.8 percent from 1.9 percent.
The price of crude oil is 24% higher than it was on January 1st this year.
THE BROAD MONETARY AGGREGATE M3
The ECB says that the annual growth rate of the broad monetary aggregate M3 decreased to 8.5% in June 2006, from 8.8% in May. This represents the first moderation in the annual growth rate of M3 since the turn of the year (see Chart 4 above). It was partly attributable to a base effect and partly to a deceleration in the month-on-month growth rate of M3. The latter brought the annualised three-month growth rate of M3 to 9.1% in June, down from 11.5% in the previous month. The annualised six-month growth rate of M3 remained unchanged at 9.6% in June.
The Bank says that the latest monetary data support the view that the prevailing low level of interest rates in the eurozone continues to be a key factor driving M3 growth. The stimulative role played by low interest rates in the period since mid-2004 is reflected, on the components side, in the continued large contribution of the most liquid components to annual M3 growth and, on the counterparts side, in the ongoing strength of the annual growth rate of MFI loans to the private sector.
As illustrated by Chart 5, since mid-2004 growth in M3 and growth in loans to the private sector have broadly strengthened in a fairly similar fashion. This contrasts with the previous period of strong M3 growth observed between 2001 and mid-2003, which was driven mainly by portfolio shifts into monetary assets during a period of heightened economic and financial uncertainty. At that time, the strengthening of M3 growth was accompanied by a modest annual growth of loans. Rather, the strength of M3 was attributable to large net inflows in the net external assets of the MFI sector associated with the repatriation of investments previously made abroad by eurozone residents.
The ECB says that given the robust growth in money and credit over the past few quarters, liquidity in the eurozone remains ample by all plausible measures. Ongoing strong money and credit growth in a context of already ample liquidity points to continued upside risks to price stability over the medium to longer term, particularly in an environment of improved economic sentiment and robust housing market dynamics.
ECB August 2006 Bulletin
