Euro zone rates likely to maintain status quo

Euro zone interest rates appear even less likely to rise next week after data showed economic growth in the 13-country region might have lost some momentum and that inflation remained under control.

Economic confidence fell in August for the third consecutive month, led by declines in the service sector, construction and among consumers, according to the European Commission.

The European Central Bank (ECB) may argue that growth prospects remain favourable - and economists note that the European Union executive's "economic sentiment" indicator is still high by historical standards. Yet at a time of heightened uncertainty stemming from market turmoil, the ECB's governing council is widely expected to maintain its main interest rate at 4 per cent when it meets next Thursday.

On August 2 the president of the ECB hinted strongly that a quarter-point rise was likely at the September meeting. But the financial market turbulence, which saw the ECB launch a series of unprecedented liquidity-boosting operations, has since blown those plans off course.

Last week, Trichet indicated the ECB would keep its options open, and take a decision only when it met next Thursday. But a rise in borrowing costs would now shock financial markets. 'Hiking interest rates would be a dangerous move,' said Marco Annunziata, economist at Unicredit. Financial markets have priced in scant chance of a rise next week and little chance of a rise in October, with talk starting to focus on when the ECB might cut borrowing costs. Pedro Solbes, Spain's finance minister, said that he believed 'the fundamental part of the interest rate tightening cycle has been and gone'.

Euro zone inflation data showed consumer prices rose at an annual 1.8 per cent in August, remaining exactly within the ECB's target range of an annual rate "below but close" to 2 per cent. The ECB is likely to argue that inflation will rise later this year and hint that its inclination remains to raise borrowing costs at some point. After years in the doldrums, euro zone growth has revived dramatically over the past year, and at least some on the ECB's governing council would argue that the effects of a long period of low interest rates are still being felt.

The Bank of England is also thought unlikely to raise rates when its monetary policy committee meets on Thursday: UK inflation was unexpectedly low in July, the market turmoil has increased the risks of a global economic slowdown, and the effect of five rate rises over the past year has still to be felt. Most economists believe the UK central bank will wait and see for some time before considering raising rates. They argue that the hurdle the bank requires to jump before raising rates has risen sharply since the turmoil started playing havoc with credit and money markets.

The economic outlook for Europe and the US has become noticeably cloudier in recent weeks. Recent data indicate that higher interest rates and a strong euro have fed through into a noticeable slowdown in activity from the peak growth rates seen at the end of last year. Like the US Federal Reserve, the ECB may acknowledge that financial market turmoil has added to the downside risks - although it is too early to judge its impact.

The Commission's euro zone economic sentiment index dropped from 111.0 in July to 110.0 in August - the lowest reading since February. Industrial confidence remained unchanged, but the mood in the construction sector was dragged lower by a sharp fall in confidence in the Spanish industry to the lowest since July 2004. Consumer confidence fell sharply in Germany - perhaps reflecting the particular difficulties faced by the country's banking sector as a result of the US subprime mortgage crisis.

Source: Gulfnews
Date: 05.09.2007 [87]