ECB Officials Signal Rate Increase Still Likely After Quake

European Central Bank officials indicated the economic uncertainty caused by Japan’s earthquake may not deter them from raising interest rates next month.
ECB Executive Board member Gertrude Tumpel-Gugerell and Governing Council member Yves Mersch both said yesterday that “strong vigilance” is necessary to keep a lid on inflation, a phrase the central bank uses to signal a rate increase is imminent. ECB President Jean-Claude Trichet also told the European Parliament he has “nothing to add” to his March 3 remarks, when he said policy makers may raise the benchmark rate from a record low of 1 percent at their next meeting in April.
The euro rose above $1.42 for the first time since November and government bonds declined as investors increased bets on higher ECB borrowing costs. Those bets had been pared in the wake of the devastating March 11 earthquake and tsunami in Japan, which damped economic sentiment globally.
“Obviously the current assessment could change depending on events going forward but for now, the signals from the ECB have been pretty clear and back up the early March ‘heads up’ for a hike on 7 April,” said Ken Wattret, chief euro-area economist at BNP Paribas SA in London.
ECB Executive Board member Juergen Stark said that, given the “heightened uncertainty” caused by events in Japan, “I cannot make any commitment for the ECB” on an April rate increase, according to the text of a March 18 interview with Nikkei newspaper published by the ECB today. Still, “there are good reasons to normalize the monetary policy stance” and the situation in the euro area “has not changed” in the short term, he said.

Inflation Risks

“The risks to medium-term price developments are tilted to the upside,” Tumpel-Gugerell said yesterday in a speech in Salzburg, Austria. “Against this background, strong vigilance is, of course, necessary and we are monitoring the situation closely,” she said, adding the ECB is “ready and determined to take appropriate action” if needed.
Inflation in the 17-member euro-area accelerated to 2.4 percent in February and has been in breach of the ECB’s 2 percent limit since December.
“It is crucial at this stage to avoid that the recent rise in inflation translates into broad-based second-round effects, for instance via price-setting or higher wages,” Trichet said. “Such effects would give rise to broad-based inflationary pressures over the medium term.”

‘Ready to Act’

ECB council member Mario Draghi, who economists say is the frontrunner to succeed Trichet when his eight-year terms ends on Oct. 31, said in a speech in Milan that the central bank will act in a “firm and timely manner” to control inflation and that policy makers have to “remain vigilant in safeguarding price stability.”
Mersch, another potential candidate to succeed Trichet, said the ECB “stands ready to act in a resolute manner and at the appropriate time.”
Tumpel-Gugerell said the surge in oil prices above $100 a barrel is a “cause for concern.”
The ECB’s latest forecasts, which show inflation averaging 1.7 percent next year, “do not take into account the recent oil-price hikes and are based on the assumption that wage pressures will remain subdued,” she said.
At the same time, “all available forecasts indicate that the gradual recovery of economic activity in the euro area is likely to continue,” Tumpel-Gugerell said. “There are a number of positive signals” and “the overall economic situation is actually rather favorable.”