ECB rate may rise to 4% in 2007 as sustained period of global economic growth forecast to beat 40-year record

European
ECB rate may rise to 4% in 2007 as sustained period of global economic growth forecast to beat 40-year record
By Finfacts Team
Jan 1, 2007, 15:56

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Source: IMF

The world economy is set for another year of impressive economic growth. Having expanded by an average of more than 3% a year so far this decade, growth in recent years at a rate of 5% matches the golden years of the 1960's. 2007 is forecast to be Europe's year with growth of 2% expected to match a slowing US while Asian growth will continue to be boosted by the region's economic powerhouses, China and India.

The European Central Bank is expected to raise its key interest rate to 3.75% by March, despite the strength of the euro and a rise to 4% will be inevitable by the autumn if robust economic and money supply growth is sustained.

The 1 year Euribor interest rate rose to 4.028% on Friday, Dec 29, 2006.

The euro has traded Monday at $1.3176 against the dollar. It gained 11.4% against the US currency in 2006. Sterling gained 13.8%.

Broad money supply growth M3 - a mix of cash, short-term bank deposits and money market instruments - which is an indicator that is more closely watched by the ECB than other central banks, and last Friday, it was reported that the annual rate of growth of M3 increased to 9.3% in November 2006, from 8.5% in October 2006. The three-month average of the annual growth rates of M3 over the period September 2006 - November 2006 rose to 8.8%, from 8.4% in the period August 2006 - October 2006.

European Central Bank President Jean-Claude Trichet
The annual growth rate of total credit granted to Eurozone residents decreased to 8.7% in November 2006, from 9.1% in October. The annual rate of growth of credit extended to general government decreased to -3.9% in November, from -2.3% in October, while the annual growth of credit extended to the private sector declined to 11.9% in November, from 12.1% in October. Among the components of the latter, the annual rate of growth of loans to the private sector stood at 11.2% in November, unchanged from the previous month. The annual growth rate of loans to non-financial corporations increased to 13.1% in November, from 12.9% in October.

The annual growth rate of loans to households stood at 8.7% in November, unchanged from the previous month. The annual rate of growth of lending for house purchase declined to 10.2% in November, from 10.4% in October. The annual rate of growth of consumer credit stood at 7.9% in November, compared with 8.0% in October, while the annual growth rate of other lending to households increased to 3.1% in November, from 2.5% in the previous month. Finally, the annual rate of growth of loans to non-monetary financial intermediaries (except insurance corporations and pension funds) decreased to 15.9% in November, from 17.7% in the previous month.

The increase in cash holdings, boosted by ECB rate rises from December 2005 that raised the key rate from 2% to 3.5%, has helped expand M3 growth and analysts said the latest spike was due more to a rebound in short-term deposits and money market funds. The decline in household mortgage borrowing has been counterbalanced by corporate credit, driven by private equity deals, accelerating to 13.1%, the highest since records began in 1998.

Eurozone interest rates "still low"

Euro zone interest rates are still low, despite recent hikes, Bank of Luxembourg President and ECB Governing Council member Yves Mersch said last Friday.

"The principal rates in the Eurosystem remain low in historical terms and its monetary policy is accommodative," Mersch said in a New Year's statement.

Incoming ECB Governing Council member Mitja Gaspari said there was a lot of liquidity in the system which posed a potential price risk, echoing comments from President Jean-Claude Trichet.
“This demands that the ECB and its Council strictly follow these processes and when necessary act, which is in line with definition of the ECB’s function,” he said at a news conference in Ljubljana, last Friday in advance of Slovenia’s adoption of the euro today Monday, Jan 1, 2007, five years after the debut of euro notes and coins.

The Eurozone now has thirteen member countries.

The ECB President Jean-Claude Trichet said in testimony to a committee of the European Parliament on Dec 20th, that inflation risks remain, signalling that he'll likely support interest rate increases this year.

"Inflation rates are likely to increase again in early 2007," Trichet said. "This outlook for price developments remains subject to upside risks."

Trichet referred to the cost of oil, excess liquidity, tax increases and wage demands as potential price pressures and said the central bank would be on guard.

"Acting in a firm and timely manner to ensure price stability in the medium term is warranted," he said. "The Governing Council will therefore monitor very closely all developments so that risks to price stability over the medium term do not materialize."

The code "monitor very closely" is interpreted by financial markets that there will be more rate increases in the coming months.

Contrasting economic fortunes for Germany and France

Last year, Europe emerged from a decade and a half of sluggish growth with the Eurozone's top two economies Germany and France, showing impressive improvements in their economies. However, in the third quarter of 2006, French economic growth stalled with an annual GDP growth rate of 1.8%, down from 2.5% in the second quarter while the German economy was up 2.3%, following a 3.2% rise in the first quarter and a 1.3% rise in the second quarter of 2006.

The German Ifo Business Climate index in December surged to its highest level since the reunification boom of the early 1990's while the rise in the standard VAT rate from 16% to 19% with effect from today, suggests that there is widespread confidence that the economy will overcome the challenge.

In December France's Prime Minister Dominique de Villepin urged Europe's politicians to reassert control over their national economies and to restrict the powers of the ECB.

Ségolčne Royal, socialist candidate for the presidential elections in May, has gone even further, accusing ECB president Jean-Claude Trichet of usurping democratic authority. "It's not for Mr Trichet to dictate the future of our economies: it's a matter for our leaders chosen by the people. We must completely change the charter of the central bank," she said.

Frenchman Trichet who as President of the Banque de France had to face down interference from politicians, said in response:

"We are independent because it has been decided by our political democracies. As you know the ECB is an apolitical institution working for the sake of all 315 million fellow citizens whatever their sensitivities. The Treaty of Maastricht has created an independent institution that works for all sensitivities, without any exceptions. And we are proud of that. The people asked for us to do our job independently through a Treaty that has been signed by all governments and ratified by all parliaments by the people of Europe directly, which was the case in France. It is true that creating an independent institution was a very important decision. In France it called for a change of the Constitution of the fifth Republic, a change which was voted on 25th June 1992 with a qualified majority (3/5) by the Congress in Versailles."

Read text of Dec. interview with the Der Tagesspiegel, the Luxemburger Wort and Ta Nea newspapers here.

Global economy in 2007

A slowdown in the US economy will likely result in the rate of global growth in 2007 to slacken but Asia and Europe are expected to achieve relatively robust growth rates.

US growth could be the slowest in the past five years. The unemployment rate, already at a low level, is likely to increase. Despite this economic slowdown, most economists expect a recession-free 2007, the sixth consecutive year without a downturn.

As a contracting US housing market dampens American demand for foreign-made electronics, clothing and other merchandise, the rising number of middle-class consumers in China, India and the rest of emerging Asia are expected to counter the decline.

Europe's growth rate is also expected to slow, but the outlook is also relatively positive because of renewed consumption and falling unemployment.

"While the world's other major economies will be affected by slower U.S. growth, their own domestic demand should continue to drive global growth," Swiss investment bank UBS said in its year-end outlook for the global economy.

The International Monetary Fund's world's economic growth as a whole is projected to fall to 4.9% next year from an estimated 5.1% in 2006. The developed economies will see lower growth rates. The Organization for Economic Cooperation and Development has reduced its 2007 growth forecast for its 30 mainly industrialized member countries to 2.5% - the lowest rate since 2003 - from its previous forecast of 2.9%.