ECB: Vigilant Or Not?

While the ECB is widely expected to leave the main refinancing rate at 1.25% in May, the focus is on the accompanying statement and the press conference as clues on the next rate hikes may be provided. Although President Trichet had said after April's rate hike that policymakers 'did not decide today that it was the first in a series of interest rate increases', recent economic developments and comments from ECB members suggested that further tightening later in the year is highly likely. The market will probably search for the 'vigilant' language in the statement as it signals a rate hike in the coming meeting. Our bottom line is that the next rate hike will be in July but a raise in June cannot be ruled out should inflationary pressures accelerate faster than anticipated.

 

Headline CPI jumped +1.4% m/m and +2.7% y/y, driven by rising food and energy prices, in March. This follows a +0.4% and +2.4% increase on monthly and annual bases respectively. The uptrend in price levels is now obvious and, as an 'inflation-targeter', the ECB should act further to curb it from excessively overshooting, and to eventually bring it back to, the limit. Sentiment indicators fell in April with economic sentiment index slipping to 106.2 from 107.3 in March. Manufacturing, retail and consumer confidence also eased. Concerns over sovereign debt problems in peripheral countries should remain an overhang in coming months. Separately, ECB's latest quarterly Bank Lending Survey showed tighter credit standards in banks in 1Q11. Banks expect to further tighten their standards moderately in the coming quarter. However, these are not going to derail ECB's commitment to combat inflation.

 

We expect the May accompanying statement will be similar to the one in April. The ECB will reiterate the importance of preventing recent price developments from giving rise to 'broad-based inflationary pressures over the medium term'. Policymakers will again pledge to 'monitor very closely all developments with respect to upside risks to price stability'. We do not expect the reappearance of the word 'vigilant' in May. However, if it does reappear, that may indicate a rate hike will come next month.

 

Along with the rate hike in April, the ECB increased the deposit rate and marginal lending rates by +25bp to 0.5% and 2.0% respectively, leaving the interest rate corridor unchanged. We expect this will remain unchanged in May. Decisions on liquidity provision will come in June, instead of the upcoming meeting, as the 3-month tender expires with the current full allotment on June 29.