ECB May Hold Rate at 2 Percent Today as Economy Strengthens

[HenryTo]

Looks like the "do-nothing" policy still reigns in Europe - no Euro carry trade for now unless the Fed Funds is raised to 4% or 4.25% by the end of this year.
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ECB May Hold Rate at 2 Percent Today as Economy Strengthens, Survey Shows

ECB May Hold Rate at 2% as Economy Strengthens, Survey Shows
Aug. 4 (Bloomberg) -- The European Central Bank will probably set its benchmark interest rate at 2 percent for a 26th month today as increasing signs of an economic recovery alleviate the need for lower borrowing costs, a survey of economists showed.

``The risk of a cut by the ECB has receded,'' said Lorenzo Codogno, co-head of European economics at Bank of America in London. ``The euro-zone economy will recover, but gradually. There will be no change in rates till the middle of next year.''

The euro's 10 percent decline against the dollar this year has given the ECB two reasons to resist political pressure for lower interest rates. The single currency's depreciation is making European goods cheaper abroad, helping the economy strengthen after a second-quarter slowdown. It is also exacerbating record oil prices, pushing inflation above the ECB's 2 percent ceiling.

European manufacturing expanded in July for the first month in four as the weaker euro fueled export demand, a survey of purchasing managers by NTC Research on Aug. 1 showed. At the same time, inflation accelerated to 2.2 percent on soaring energy costs, the European Union's statistics office said on July 29.

The euro was at $1.2336 yesterday, down from a record $1.3666 on Dec. 30. Oil rose to a record $62.50 a barrel. All economists surveyed by Bloomberg expect the ECB to keep the refinancing rate at the six-decade low at least until March next year.

`Benefit of the Doubt'

The ECB's 18 policy makers will discuss rates by teleconference and announce their decision at 1:45 p.m. They don't meet at the bank's headquarters in Frankfurt in August and there won't be a press conference following the decision. The Bank of England, which announces its decision at 2 p.m. Frankfurt time, is expected to lower rates amid signs U.K. growth is slowing.

Politicians including Italian Prime Minister Silvio Berlusconi and German Economy and Labor Minister Wolfgang Clement have urged the ECB to pare rates to boost growth in the euro economy, which will lag its U.S. counterpart for the 13th year in 14 this year, according to European Commission forecasts.

The commission predicts growth of just 1.3 percent in the euro area, compared with 3.6 percent in the U.S. Still, the commission said July 18 it expects growth to rebound in the second half after a ``disappointingly slow'' second quarter.

Business confidence rose in Germany, Italy and France in July, signaling growth may pick up. European service industries growth also accelerated in July, a report yesterday showed.

``The ECB will be comforted by signs of improving industrial confidence,'' said Julian Callow at Barclays Capital in London. ``The economy needs to be given the benefit of the doubt.''

Goldman Abandons Forecast

Goldman Sachs Group Inc. has abandoned its forecast for an ECB rate cut, saying this week that ``good economic news'' and the euro's drop will allow the bank to keep rates on hold this year.

Investors agree, interest-rate futures trading shows. The implied rate on the December Euribor interest-rate future contract was at 2.19 percent in Frankfurt yesterday, up from 1.96 percent June 22. The contracts settle to the three-month euro area inter- bank offered rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's launch in 1999. The Euribor three-month money market rate was 2.13 percent.

``The ECB will only consider a cut if the expected recovery does not materialize by the end of the year,'' Bank of America's Codogno said. ``The bank fears that if they cut rates, it will distort the economy, especially in the housing market.''

The lowest credit costs in six decades have pumped more money into the $9.3 trillion economy than needed for inflation-free growth and fueled double-digit house price increases in countries such as France and Spain.

Inflation Risk

M3, the ECB's measure of money supply, rose 7.5 percent in June from a year earlier after growing 7.3 percent in May. The bank says a rate above 4.5 percent risks stoking inflation. M3 growth rates have exceeded 4.5 percent every month since May 2001.

``It is clear that this building up of liquidity can't go on forever,'' ECB council member Nout Wellink said in an interview with the International Herald Tribune published on July 15. ``At the end of the day, what you will get is inflation.''

Euro-region inflation accelerated to 2.2 percent in July, a seven-month high, from 2.1 percent in June, Eurostat said in Luxembourg on July 29. The ECB aims to keep inflation just under 2 percent.

``I think the bank has shifted more in favor of a rate hike, but with a 12-month horizon,'' said Callow. ``Rate cuts are very much off the agenda.''