The President of the European Central Bank Jean-Claude Trichet said at a press conference in Frankfurt Thursday afternoon, following the decision of the Governing Council to keep the key ECB interest rate at 3.75%, that monetary policy remains accommodative, risks to price stability remain on the upside and the continued high growth of money/supply requires "very careful monitoring" against a backdrop of a robust economy.
In answer to a question, Trichet said that he would not wish to change current market expectations regarding the month of June - a clear signal that the key interest rate will be raised from 3.75% to 4%.
AIB Bank's Economic Research Unit in a comment on the ECB Governing Council's deliberations today, said that the strong economic growth in the Eurozone is impacting on the labour market, with employment rising by 0.4% per quarter over the past year. The unemployment rate fell to 7.3% in February, down from 8.3% at the start of 2006. Again, the fall in unemployment has been most marked in Germany.
AIB said that the favourable prospects for the economy suggest that the expected rate hike in June is unlikely to be the last in this cycle. A continuation of the strong economic performance is likely to mean that, at some stage, the ECB will deem it appropriate to increase rates beyond 4% to a somewhat restrictive policy stance.
This could occur before the end of this year. The market is beginning to contemplate such a move but it has not yet fully discounted rates rising to 4.25%. Yields, though, have risen in recent weeks on increasing bearishness about interest rate prospects. Two and five year swap rates are now above 4.3%, moving closer to AIB Bank's long standing forecast that swap rates could rise to 4.5% later this year.
On Thursday, a new economic forecast for the Eurozone, was issued by three leading European economic institutes - Germany's Ifo Institute, INSEE in Paris and ISAE in Rome and contains estimations (for the previous quarter) and short-term forecasts (for the current and the following quarter) for real GDP, consumption, industrial production, investment and inflation in the Euro-zone.
In 2006, the Eurozone recorded its steepest real GDP growth since 2000, at 2.8%. Both domestic and external demand contributed positively to this figure. GDP growth is likely to slow temporarily to 0.5% in Q1 2007, bouncing back to 0.6% in Q2 and Q3.
Industrial production is expected to stabilize at a reasonably high level. Germany’s VAT hike should have a weaker impact on euro-zone consumption than initially forecast: private-consumption growth is expected to stabilize at 0.4% in Q1, gradually accelerating to 0.5% in Q2 and 0.6% in Q3, in line with the strengthening of the labour market. Investment should continue to expand by 1.0% per quarter.
Assuming an oil price of $60-65 per barrel and an exchange rate of about $1.30 per euro, headline inflation—thanks to negative contributions by energy prices—should decline to 1.6% in Q2 and 1.7% in Q3 2007 after a small jump to 1.9% in Q1.
