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ECB Watch: Does normalization imply a ‘refi’ rate of 4% next year?

The ECB sets great store by the transparency of its decision-making process and the clarity of its communication with the outside world. ECB president Jean-Claude Trichet was reminding us of this again last month.

Faced with a mixed bag of evidence about recent economic developments, the European Central Bank left its key interest rates unchanged in April, in the wake of the 25 basis point increase in its main refinancing rate, to 2.5%, in March. GDP growth in the final quarter of 2005 was confirmed at 0.3%, down on the third quarter’s 0.6%, and the various monthly indicators of activity showed at best lacklustre growth at the beginning of 2006. However, survey-based data were pointing to buoyant confidence and economic sentiment, headline inflation was remaining stubbornly above 2%, there were signs of a feed-through from high oil prices and those of other commodities along the domestic price chain, and money and credit growth continued to balloon.

It is against this background that the ECB has been preparing financial markets for another rate rise in June, with a hint of further increases in the months ahead. At his regular press conference following the governing council’s April 6 meeting, ECB president Jean-Claude Trichet pointed out that interest rates were still very low and that monetary policy remained “accommodative”. He warned that, with risks to price stability continuing on the upside, the ECB was in a “process of normalization” to prevent those risks from materializing, which was why it had raised rates twice already and why there would be an increase in the future.

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