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ECB not expected to raise rates at August meeting

Latest update : 2008-08-03

The European Central Bank in Frankfurt is holding a one-off meeting this month, rare for August, to discuss Europe's economic woes, including inflation. Experts doubt this will lead to another hike in the interest rate.

The European Central Bank holds an exceptional meeting this month amid signs of persistent market turmoil, but analysts expect interest rates to stay on hold even though the eurozone might be stumbling toward recession.
The ECB governing council, which does not usually meet in August, raised its main lending rate to 4.25 percent last month to stem inflation, which is now at a record 4.1 percent, more than double the bank's target of just below 2.0 percent.
This time around however, "the ECB is on hold," Citibank analyst Juergen Michels said.
The bank would "probably leave rates unchanged and give a 'no bias' statement" after the decision, he forecast.
"We expect the ECB to be on hold for at least the next 12 months," added Bank of America economist Holger Schmieding.
Eurozone economic conditions have deteriorated sharply in recent months, and manufacturing activity in the 15 member countries fell last month at the fastest pace in more than five years, according to a purchasing managers' index compiled by data and research group Markit.
The drop to 47.4 points was the steepest monthly fall since June 2003 and marked the second straight month below the 50-point threshold that indicates a contraction.
It added "to the mounting evidence that the eurozone economic downturn is deepening," said Global Insight economist Howard Archer.
Michels added that "the ECB will no longer describe the economic fundamentals as 'sound'," as it has in recent months.
In a sign of potential financial fragility, the ECB the US Federal Reserve and the Swiss National Bank last week modified operations that provide US dollar funding to European banks.
Some of those banks are still writing down the value of assets amid chronic money market tension triggered by the collapse of the US market for high risk, or subprime, mortgages a year ago.
Under the terms of a plan that starts on August 8, the ECB will extend to 84 days a period over which it lends US dollars to commercial banks, almost three times longer than a previous refinancing term of 28 days.
On the economic front meanwhile, surging oil and food prices have pushed eurozone inflation to its highest level since the bloc was formed in 1999, according to an official estimate.
Oil prices that hit records close to 150 dollars a barrel in early July have fallen since but have also sparked a slump in eurozone economic confidence, which fell in July at the fastest pace since just after the September 11, 2001 attacks in the United States.
Even employment, which the ECB considers proof that its monetary policy is working, now shows signs of weakening.
"We expect the risk of a much sharper downturn in the labour market to keep the ECB on hold despite the current inflation overshoot," Schmieding said.
UniCredit Markets economist Aurelio Maccario added: "We wouldn't say it very loud, but there may be fair chances that July's 4.1 percent may have been the peak in inflation."
He also warned that "the eurozone economy is heading toward a stagnation phase bound to last at best a few months."
Maccario said the ECB would "probably state that it is too early to deem as entrenched the recent (downward) movement in oil prices" and that "money statistics will be a key signal for the rate outlook."
The ECB's bank lending survey is due a day after the rate decision, and Maccario suspected it would show that lending was set to slow rapidly.
"A decisive inversion in the credit cycle may open the way to rate cuts in 2009," he forecast.
Citi analyst Michels looked for remarks on collateral the central bank accepts during its refinancing operations.
Reports "that the ECB is holding a huge amount of 'toxic stuff' in their balance sheets" might draw comment from ECB president Jean-Claude Trichet at a press conference which follows the rate announcement, he said.

Date created : 2008-08-03