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Economists Raise ECB Forecasts After Trichet Urges `Vigilance'

Economists raised their forecasts for European Central Bank interest rates after President Jean-Claude Trichet said yesterday the bank will show ``strong vigilance'' against inflation, a survey shows.

The ECB will increase its benchmark rate to 3 percent on Aug. 3 from 2.75 percent, all but one of the 24 economists surveyed by Bloomberg News said. A week ago, just five out of 23 forecast such a move. Economists also said the ECB will raise the refinancing rate more than they expected, taking it to 3.5 percent in February instead of just 3.25 percent, the survey showed.

Trichet used the word vigilance to signal the ECB's last three rate increases. The bank, which left rates unchanged yesterday, tightened access to credit as faster economic growth, record oil prices and galloping money-supply growth keep inflation above its 2 percent limit.

``The early use of the `vigilant' word raised significantly the risk that the ECB no longer delivers only one 25 basis point rate hike at the end of each quarter, but will step up the pace,'' said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt.

Trichet said yesterday the ECB's governing council will break with tradition and meet in Frankfurt on Aug. 3 rather than discuss rates with a telephone conference call.

``We will exercise strong vigilance to ensure that risks to price stability don't materialize,'' said Trichet at a press conference yesterday. A ``progressive withdrawal of monetary accommodation'' would be ``warranted'' should the economy grow as forecast and inflation stay above its 2 percent limit, he said.

`Elevated' Inflation

Investors have already raised their bets the ECB will step up the pace of increases and take the rate to 3.5 percent by year end as exports and investment drive growth in the region. Services and manufacturing expanded at the most in six years in June and unemployment in May fell to the lowest since October 2001.

At the same time, oil prices close to $75 a barrel are threatening to keep inflation at a level that Trichet describes as ``elevated'' and M3 growth, the gauge of money supply used by the ECB, in May was the fastest in more than three years.

The ECB is tightening access to credit along with the world's other major central banks. The U.S. Federal Reserve has lifted borrowing costs on 17 straight occasions since June 2004, taking its key rate to 5.25 percent on June 29 and suggested further moves may be needed.

Economists expect the Bank of Japan to raise rates next week after keeping them near zero since March 2001.

The ECB expects the euro-region economy to expand about 2.1 percent this year and an inflation rate of 2.3 percent. It would be the seventh year the ECB failed in its aim to keep inflation just below 2 percent.

Pre-Announcing Decision

``Against our expectations, ECB President Trichet all but pre-announced a rate hike,'' said Elga Bartsch, an economist at Morgan Stanley in London.

Bartsch, who says the ECB will raise its key rate to 3.5 percent by the end of the year, nevertheless says the bank will stop raising borrowing costs next year as growth slows and a stronger euro makes European exports more expensive abroad.

The yield on the three-month futures contract for December rose to 3.68 percent from 3.65 percent yesterday, showing investors have fully priced in a further 75 basis points of ECB increases this year, compared with 50 basis points on June 12.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's debut in 1999.

To contact the reporter on this story:
John Fraher in Berlin at jfraher@bloomberg.net.
Last Updated: July 6, 2006 19:13 EDT

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