European
European Central Bank expected to keep benchmark interest rate on hold at 4%; Bank of England base rate cut likely
By Michael Hennigan, Editor and Founder of Finfacts
Jan 10, 2008, 05:06

Lucas Papademos Vice President and Jean-Claude Trichet President, of the European Central Bank

The European Central Bank's Governing Council will meet in Frankfurt today to decide on interest rate policy while in London, the Bank of England's Monetary Policy Committee meets against a backdrop of recession fears.

Eurozone inflation in December remained at the elevated level of 3.1% because of surging food and energy prices and ECB President Jean-Claude Trichet recently said that what he had termed an inflation "hump," is likely to be more protracted than he had expected last November.  

The ECB's inflation target is "below but close to" 2% and following the meeting of the Governing Council in December, Trichet said that some members had called for a hike in interest rates. However, it's likely that the Governing Council will decide today to keep its benchmark rate at 4%. Economic growth in the Eurozone is moderating and on Wednesday, three European economic institutes forecast that in the second quarter of 2008, GDP will grow at an annual rate of 2.1% compared with the expected performance in 2007 of 2.7%.

The ECB President will report on the easing of the credit crunch following the provision of emergency funding of €348.6 billion to the Eurozone banking market - more than a half trillion dollars - on Dec 17th. In every trading day since, the 3-month Euribor inter-bank rate has fallen and on Wednesday (Jan 09) was 4.597%. In early June, it was at 4.135% following the last hike in the benchmark rate to 4%. On Dec 17th, the 3-month rate was 4.979%. The 1 month rate was at 4.930% compared with 4.212% yesterday. While the evidence of an abating credit crunch may have prompted a consensus on the Governing Council for a benchmark hike, the ECB cannot be totally oblivious to the trends in the US and UK.

On Tuesday, US Investment bank Goldman Sachs said that the US economy may already be in recession and it forecast a fall in the federal funds rate from the current level of 4.25% to 2.50%.

In Frankfurt today, ECB President Jean-Claude Trichet will warn again about the risk of "second-round effects," - wage demands - that would be triggered by the current spike in Eurozone inflation.

The FT says that after years of wage stagnation in Europe’s biggest economy, calls for substantial pay increases are growing louder – and prompting warnings from economists about the potential impact on jobs and inflation.

The ECB will hold off on rate cuts for as long as possible to counter wage settlements above productivity growth levels. Trends in Germany in particular, are closely monitored by the ECB.

Bank of England

Recession fears intensified in the UK on Wednesday as the economy's biggest clothing retailer Marks & Spencer reported that sales in December had fallen to a 2-1/2 year low. The report coincided with  data showing a fall in UK consumer confidence.

M&S's share price plunged 18.72% in London.

A quarter point cut in the Bank of England base rate from its current level of 5.5%, wouldn't be a surprise.

The Bank of England will announce its decision at 12 noon in London. The ECB decision will be announced in Frankfurt at 1.45 pm - 12.45 pm Irish time.