9 July 2004, 16:12  Trichet - ECB had good reason to keep rates steady

The European Central Bank had good reason to buck the trend of global interest rate tightening earlier this month, its president Jean-Claude Trichet said on Friday, but warned that the central bank is "particularly vigilant" on inflation. Several European finance ministers this week had urged the ECB not to follow the Federal Reserve in tightening credit, saying they hoped the ECB would stick to its historic low interest rates at 2.00 percent. In a speech at the Europlace international finance forum, Trichet explained that the ECB's Governing Council held rates steady because it is confident that the 12-nation euro zone is on track to achieve stable prices in the medium term. "Europe is Europe and the United States is the United States. They had good reasons to increase rates and we had good reasons to keep rates unchanged," he said. But Trichet laid out a number of risks to this stable inflationary environment. Echoing comments he made last week after the ECB's decision, he cited strong global recovery which puts upward pressure on commodities prices including oil, the uncertain path of government taxes and administered prices, and relatively high inflation expectations in financial market indicators.
"While such measures always need to be interpreted with caution, their development calls for particular vigilance," Trichet said. In Madrid, European Monetary and Economic Affairs Commissioner Joaquin Almunia said in a television interview he did not foresee a rate hike in the euro zone in the near term. "The situation in the European economy, in the euro zone, is not the same as that of the North American economy," he said.
ON HOLD
Analysts said Trichet's wary tone has seeded the ground for a rate increase if inflation disappoints on the upside. But his remarks overall reinforce the view that the ECB is on hold. "It is pretty much neutral," said Peter Fertig, chief fixed income analyst at Dresdner Kleinwort Wasserstein. "He keeps his options open, but we don't expect a change in rates this year and the first half of next year." Financial markets already are pricing in a rate increase early next year, and the September Euribor contract, a barometer of short-term rate expectations, was little changed after Trichet's comments. The euro zone economy grew by about a 2.3 percent seasonally adjusted annual rate in the first quarter, compared with a more robust 3.9 percent rate in the United States. A number of quarters of strong growth and recovery in the jobs market prompted the Federal Reserve in late June to raise its ultra-low official rates by quarter of a percentage point for the first time in four years.
NO TARGETS
Trichet defended vigorously the ECB's monetary policy decision-making framework, which French Finance Minister Nicolas Sarkozy criticised earlier this week for being over rigid. Under the ECB's framework, its price stability goal is to achieve inflation just below two percent in the medium term, and it does this by looking at economic and monetary data to discern inflationary trends. Sarkozy criticised this approach for running the risk of setting interest rates too high in pursuit of too low an inflation level. Instead he commended the inflation targetting model, which sets a broader inflation band, as used by the Bank of England. But Trichet said this model presents difficulties and lacks flexibility because it uses information inefficiently and is based upon a limited set of assumptions. "Attempts to base monetary policy decisions solely on inflation forecast numbers would involve significant limitations," Trichet said. "In the end monetary policy requires judgment on the part of the policymaker to assess not only the plausibility of all possible scenarios but also the nature of the shocks and the best policy reaction in order to deal with this uncertain environment," he said. Trichet also defended the central bank as highly transparent in its decision making, giving a news conference after its policy sessions. It does not publish votes or minutes because it is the council that decides, not an individual.///

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