Tags: EU | Europe | Interest | Rates

ECB Chief Signals Pause in Interest Rate Hikes

Thursday, 08 Sep 2011 09:38 AM

The European Central Bank signaled on Thursday that its interest rate rise cycle had been halted, saying euro zone inflation risks were no longer skewed to the upside and economic growth would be slow at best.

"We expect the euro area economy to grow moderately, subject to particularly high uncertainty and intensified downside risks," President Jean-Claude Trichet told a news conference after the ECB left rates at 1.5 percent, following hikes in April and June.

Inflation should fall below 2 percent in 2012, Trichet said, and price risks were "broadly balanced." That assessment marked a change from last month, when he said there were "upside risks to price stability." The change in the ECB's inflation view suggests it has abandoned its policy tightening course and that interest rates are now on hold.

The euro tumbled in response to the gloomy economic prognosis.

A month ago, the ECB chief had said risks to the growth outlook were balanced.

ECB staff cut their growth forecasts to a range of 1.4-1.8 percent this year from the 1.5-2.3 percent seen in June. Next year, growth is expected to be between 0.4 and 2.2 percent, down from 0.6 to 2.8 percent previously.

Inflation is now predicted to fall back to between 1.2 and 2.2 percent next year, for a midpoint of 1.7 percent, which would be below the central bank's target of close to but below two percent.

"A very thorough analysis of all incoming data and developments over the period ahead is warranted," Trichet said. "We will continue to monitor very closely all developments."

All 75 of the economists polled by Reuters ahead of the ECB's decision correctly forecast rates would stay on hold at this meeting.

Following two rate rises this year, all the signs from policymakers were that further rises had also been penciled in but a deterioration in the economy and debt crisis since then has altered the outlook dramatically.

Policymakers' failure to resolve the debt crisis has eroded confidence in the 17-country euro zone, and some private sector economists put the chance of a return to recession at least 50 percent.

While inflation remained at 2.5 percent last month, well above the ECB target, such is the concern about faltering growth that financial markets are pricing in a cut to rates as early as December.

Economists, who tend to take a broader view than that shown in market pricing, see an outside chance the ECB could cut in the months ahead, though such a U-turn would embarrass Trichet, who is unlikely to back a cut before his term ends next month.

"It's not out of the question but it's highly unlikely," said Berenberg bank economist Holger Schmieding about the chance of an ECB rate hike in the coming months.

"It would probably take a major recession ...to change the ECB's mind on rates, and I don't think we are anywhere close to that." ITALY

Under Scrutiny

Trichet said all the ECB's extraordinary support measures were "temporary in nature," echoing a warning from his successor, Mario Draghi, earlier this week.

The ECB reactivated its bond-buying program a month ago to help hold down borrowing costs in Italy and Spain.

The ECB is concerned that by buying the sovereign bonds of Italy — the euro zone's third largest economy — it is only encouraging the Italian government to slacken efforts to shore up its finances, and has been irritated by flip-flopping in Rome.

The ECB has recently appeared to be calibrating its purchases, allowing borrowing costs to rise to raise the pressure on Italy to implement its previously promised austerity measures.

Italy responded to the renewed attack on its bonds by pledging on Tuesday to hike value-added tax having dropped key parts of its austerity package the week before.

"We have confirmation that there is implementation of what was said in terms of overall results and that, of course, is of extreme importance," Trichet said of the latest Italian measures, which were passed in the Senate on Wednesday and go to the lower house on Monday.

© 2015 Thomson/Reuters. All rights reserved.

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