European Central Bank Keep Rate at 4%

The European Central Bank will probably keep interest rates unchanged, preferring to wait for confirmation that economic growth is fanning inflation before raising borrowing costs again, a survey of economists shows.

Policy makers meeting in Frankfurt today will keep the benchmark refinancing rate at 4 percent, according to all 42 economists in a Bloomberg News survey. The bank will raise the rate to 4.25 percent in September, a separate survey shows.

The ECB has increased rates eight times since late 2005 as the fastest economic expansion in six years gave companies room to raise prices and encouraged workers to demand more pay. While last month's increase took the key rate to a six-year high, the ECB said it's still low enough to fuel growth, suggesting the bank is considering another step.

``European companies are operating at close to full capacity,'' said Elga Bartsch, an economist at Morgan Stanley & Co. in London. ``The ECB may have to increase its inflation projections. That means it will have no choice but to raise rates.''

The central bank will announce the decision at 1:45 p.m. and President Jean-Claude Trichet will hold a press conference 45 minutes later. Separately, the Bank of England will probably raise its benchmark rate by a quarter-point to 5.75 percent, also a six-year high, a Bloomberg survey shows. That decision is due at noon in London.

Raised Forecasts

By contrast, the U.S. Federal Reserve has kept its benchmark rate at 5.25 percent for a year as economic growth slowed. The Fed said June 28 that inflation is still the ``predominant'' risk facing the world's largest economy.

The ECB last month increased its inflation and growth forecasts for this year, and Trichet said then that ``acting in a firm and timely manner'' to keep prices stable remains ``warranted.''

The economy of the 13 euro nations will expand about 2.6 percent in 2007 and inflation will average about 2 percent this year and next, according to the ECB's new projections. The bank aims to keep inflation below 2 percent. The economy expanded 2.7 percent last year, the most since 2000.

``My personal feeling is the tightening cycle has not yet come to an end,'' ECB council member Nout Wellink said June 27. ``Whether we take steps will depend on incoming data.''

Government and industry reports in the past two weeks may have supported the case for higher rates. Growth in manufacturing and service industries, which account for two-thirds of the economy, accelerated in June, and unemployment fell to 7 percent in May, the lowest since records began in 1993.

Inflation Risks

Money-supply growth, which the ECB uses to gauge future inflation, unexpectedly accelerated to 10.7 percent in May, close to the fastest pace in 24 years.

Adding to the ECB's inflation concerns, the price of oil has risen 40 percent since mid-January, to $70.95 a barrel yesterday. Economic growth and rising energy prices have prompted trade unions to push for higher wages.

Germany's IG Metall, the country's largest union, on May 4 won a 4.1 percent raise for 12 months starting in June for 800,000 workers in the metals industry. German railway workers went on strike this week in pursuit of a 7 percent pay increase.

``Central banks have to closely monitor risks for inflation, which seem to be oriented upwards,'' ECB council member Guy Quaden said June 24. ``We have never said that the tightening cycle has ended.''

Hawks and Doves

To be sure, not all of the ECB's 19 governing council members have expressed concern that inflation will accelerate. Portugal's Vitor Constancio said June 24 that an increase in bond yields reflected confidence in the growth outlook ``and not so much fears of inflation in the future.''

France's Christian Noyer said in May there was no cause for concern about inflation in the euro region and predictions that interest rates would rise further after June were premature.

Euro-region inflation was 1.9 percent in June, holding below the ECB's limit for a 10th straight month. Retail sales fell for a second month, according to a survey of purchasing managers, while business and investor confidence in Germany, Europe's largest economy, declined.

Data are ``providing both hawks and doves with some arguments to support their view,'' said Holger Schmieding, chief European economist at Bank of America in London.

Investors have nevertheless raised bets on the ECB increasing rates twice more this year, futures trading shows. The implied rate on the three-month Euribor futures contract for December settlement was 4.56 percent yesterday, up from 4.45 percent on May 24.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 16 basis points more than the ECB's benchmark rate since the single currency's start in 1999.

source:bloomberg.com