ECB signals likely rate rise according to Bank of Ireland

Interest rates across the major economies are at historically low levels and on that basis there is only one way they are likely to go. The timing and pace of monetary tightening is uncertain but market interest rates in the UK and the euro area have generally risen since the turn of the year on the expectation that the respective central banks will soon start to change policy. Inflation too has risen, albeit primarily driven by higher commodity prices, and the recent spike in oil prices is likely to add further upward pressure in the near term, with the path for oil prices over the rest of the year now highly uncertain, according to Bank of Ireland’s latest Bulletin which was published today, 8 March 2011.

Author of the Bulletin, Dr. Dan McLaughlin, Group Chief Economist, Bank of Ireland said: “The US central bank targets inflation excluding food and energy and tends to see higher oil prices as negative for economic growth. In contrast, the ECB , which has an inflation target set in terms of headline inflation, is nervous when inflation is above its 2% target even if driven by oil and signalled at its March meeting that the current 1% repo rate is not appropriate given the risks to inflation which it now sees as being on the upside. Consequently it is clear that barring some unexpected developments the ECB is likely to raise rates fairly soon, and stated that a move in April was possible, albeit not certain.

“The market response was immediate and substantial, with three quarter-point rate increases now expected by year-end, a change in expectation has boosted the euro. The timing is curious nonetheless. Many analysts are stressing that global growth will slow somewhat if oil prices stay at the current level and a substantial spike higher in energy costs is a risk given the political upheavals in the Middle East and North Africa. The ECB’s own staff forecast envisages euro growth of 1.8% next year, which is hardly stellar and was anyway based on oil prices averaging $101 a barrel for the year, which is well below the current market expectation. Consequently we are not convinced that the ECB will deliver the scale of rate increases priced in by the market, particularly as the sovereign debt problems within the euro area have not gone away.

Similarly in the UK, market interest rates in sterling are consistent with three quarter point rate rises by the Bank of England over the next twelve months, the first coming in May. Inflation in the UK is currently at 4% and is generally expected to go higher in the near term and to remain above 4% through this year. Yet the UK economy slowed in the second half of 2010 and actually contracted in the final quarter, so the decision is not clear cut and it is known that the Bank of England is split. We suspect that they will wait to see how the economy performs over the coming months, so a rate rise in May is certainly not a done deal”, concluded Dr. Dan McLaughlin.

Ends

8 March 2011

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