LONDON, Oct 28: Interest rate meetings in the US and euro zone will dominate financial markets next week, with Federal Reserve hike seen as a done deal and the European Central bank expected to stay put — but perhaps not for long.
For a change, the ECB, which has kept rates unchanged at a historic low of 2 per cent for nearly two and a half years, might get more attention from the market than the Fed.
Increasingly hawkish remarks from ECB policymakers have put the spotlight on a news conference from ECB President Jean-Claude Trichet that follows the bank’s rate decision on Thursday as investors search for clues as to when the bank might start raising borrowing costs.
Short-dated euro zone bond yields have surged and the euro risen in recent days as traders have speculated the ECB may raise rates before the end of the year, though most analysts believe the economic recovery is still too fragile for the central bank to move that soon. I suspect the market will watch the ECB very closely. Most people believe the Fed will raise the fed funds rate, and stick to its script on the economic outlook. There is not much room for surprise there, said Stephen Lewis, chief economist at Monument Securities.
It will be different for the ECB. They’re up to something. After blood-curdling comments they made recently, we could very well get strengthening Trichet’s comments...they might move from strong vigilance to extreme vigilance...something like ‘we will never take our eyes off (inflation) ever again.
The Fed, which has already raised its fed funds rate to 3.75 per cent from just 1.0 per cent in mid-2004, will announce its rate decision on Tuesday.
Economists polled by Reuters expect it to raise interest rates by another 25 basis points to 4.0 per cent at this meeting.
A recent Reuters survey, carried out between October 17-24, gave mid-range forecasts for US official rates to rise to 4.25 per cent by the end of this year and 4.50 per cent by the end of March, staying at that level well into 2007.
The same poll predicts the ECB, which meets on Thursday, will wait until the second quarter of next year to increase borrowing costs.
However, the Euribor interest rate future market is already pricing in a 70 per cent chance of a move in December, and two quarter point rate hikes by June 2006.
Key data to be published in the euro zone next week include producer price inflation as well as manufacturing and services purchasing managers’ indexes.
Economists polled by Reuters expect the manufacturing PMI in the euro zone, to the released on November 1, to have risen to 52.6 in October from 51.7 in the prior month.
Activity in the service sector is also expected to pick up slightly in October, with the services PMI seen rising to 55.0 from 54.7 in September. The data is due on November 3.
With both inflation data and M3 money supply persistently staying above the ECB’s targets, activity data, such as the PMIs, are likely to be watched closely.
Analysts believe the ECB is anxious to raise interest rates as the current benchmark rate of 2 per cent, which translates into negative real rate because of a higher rate of inflation, won’t bode well for the economy.
But they reckon what might have held the ECB back from pulling a rate trigger was a lack of strong evidence that the economy is recovering at a sustained pace and that higher energy costs have passed through into wages and core consumer prices.
We believe that inflation should not pose a medium-term risk and that the ECB’s rhetoric is at least aimed at maintaining inflation expectations, said David Page, economist at Investec in London.
Rather, we think that it is the continued signs of resurgence in the euro zone economy that is likely to lead to higher rates, he said.
In the US, key economic data to be published next week include Personal Consumption Expenditure (PCE) index — believed to be the Fed’s favourite measure of inflation — on Monday. The ISM manufacturing survey is due on Tuesday, jobless claims on Thursday, and non-farm payrolls on Friday. —Reuters
