--- by Steve Whitehouse ----
PARIS (AFX) - The European Central Bank is certain to leave interest rates unchanged at its governing council meeting tomorrow, and will probably keep rates on hold for a prolonged period, economists said. The window of opportunity for further rate cuts is now closed, but it will be some time before the ECB thinks about raising rates, they said.
Consequently, the ECB will lag well behind other central banks in starting to tighten monetary policy, they said.
Of 30 economists polled last week by AFX News and Agence France-Presse, all said they expect the minimum bid rate on ECB refinancing operations to be kept at 3.25 pct at this week's meeting, forecasting that the next move in interest rates will be upwards. Strong confidence indicators, such as the German Ifo survey and euro zone purchasing managers' data, suggest that the euro zone economy is now recovering, ruling out any need for further rate cuts, economists said.
"Given the recent high inflation data and the stream of good news from surveys, we consider the window for further rate cuts shut," said Raymond van der Putten of BNP Paribas. "Ifo was the last nail in the coffin for any kind of hopes of easier policy," said David Brown of Bear Stearns. But the strong survey data are yet to be borne out by actual activity figures, and the euro zone recovery appears to be much more timid than the US rebound, economists said.
"The signs of recovery in the euro zone are still fragile and do not justify a rate increase. Our forecast that rates will only be raised at the end of 2002 is based on a scenario in which growth will only get back to its potential level at that time," said Laure Maillard of Caisse des Depots.
"We don't expect any interest rate changes in the months ahead. Up to now, leading indicators suggest that the euro zone economic recovery is lagging behind for example a recovery in the US, so an eventual tightening of monetary policy is expected to come first in the US," said Daniela Etschberger of Dresdner Kleinwort Wasserstein. Marc Touati of Natexis Banques Populaires has been critical of the ECB for not cutting rates more to support euro zone growth, and said it would therefore be wrong to raise rates now and risk quashing the recovery just as it is starting.
Inflation risks are expected to be limited in the near term, with euro zone inflation set to fall sharply in April and May as a result of base effects. It rose to a preliminary 2.5 pct in March from 2.4 pct in February, but is still on course to drop below the ECB's 2 pct price stability ceiling in the second quarter, probably reaching a low of around 1.6 pct in May, economists said.
But rising oil prices mean that inflation will probably now not stay low for as long as previously assumed, and the ECB may have to revise its forecast that inflation will stay safely below the 2 pct level after the second quarter decline.
Inflation is now likely to climb back above the 2 pct level towards the end of the year, and probably average more than 2 pct for the year as a whole, economists said.
Such concerns may have been behind recent comments by ECB chief economist Otmar Issing, which some interpreted as marking the beginnings of a shift to a tightening bias in the central bank's monetary policy stance. "Risks to price stability (from) both sides for the time being cannot be identified. But if (there are) any, then they are on the upward side and not on the downward side," Issing told a hearing of the European Parliament economic and monetary affairs committee. Nevertheless, most economists -- 17 of the 30 polled by AFX and AFP -- expect the ECB to wait until the fourth quarter before hiking rates. Six said they expect the ECB to move before then, with the earliest forecast for a June tightening move. One forecast that rates would be raised in September or October. The remaining six said rates would be left unchanged for the rest of the year or that the next move would be a rate hike in 2003.
A fourth quarter move would leave the ECB lagging behind other central banks in their moves to a tighter monetary policy. The central banks of Sweden and New Zealand have already started to raise rates.
And more importantly, the US Federal Reserve and Bank of England are both widely expected to begin hiking rates before the ECB, although no rate change is expected from this week's BoE meeting. The Fed may start to tighten policy as early as May or June and will probably raise rates more aggressively than the ECB, but this would be logical because the US recovery is clearly outpacing that of the euro zone, and Fed rates are at a much lower point than ECB rates after heavy cuts in 2001. "The ECB can wait longer and tighten less because its past easing was less aggressive," said Claudia Henke of Dresdner Bank. "For the Fed the need to reverse its course in good time and the danger of a too strong monetary stimulus is greater." Alberto Baltanas Nunez of BSCH said the US Fed funds target, at 1.75 pct, is much further from a neutral level than the ECB refi rate. The Bank of England could also start to raise rates as early as the spring, economists said.
"The ECB is highly likely to lag behind the Fed and the BoE. We see the ECB on hold until October," said Sharda Dean of Merrill Lynch. Philippe Weber of CPR said this would fit with the ECB's strategy of changing its rates less frequently than other central banks, maintaining the "steady hand" policy it inherited from the Bundesbank. "The history is short but we can see that the ECB reacts to turning points in the economic cycle about one quarter after the Federal Reserve. The result is that it has cut less than the Fed but that it has less need to raise rates quickly now," he said. Economists said there are two factors which could prompt the ECB to tighten policy earlier than currently envisaged -- oil prices and wage increases.
Council members have expressed concern about the recent rise in oil prices and Austrian National Bank governor Klaus Liebscher last week told AFX News that the ECB "has to be very very careful about future oil price developments, because they have an influence that should not be underestimated".
Beat Schumacher of Credit Suisse said central banks may have to hike rates earlier than currently expected if oil prices remain high due to Middle East tensions. He said he currently expects the ECB to raise rates in September or October, but the tightening move would be brought forward into the summer if oil prices remain high and push up inflation expectations. And the ECB is also keeping a close eye on wage developments for any signs of inflationary pressures. "We fear that the risks for an end to wage moderation have rather increased than diminished in the euro area. Not only in Germany, where IG-Metall has demanded a 6.5 pct wage increase, but also in other European countries labour unrest is on the rise," said van der Putten.