Markets brace for ECB inflation forecast

07:26 AEST Thu Mar 3 2011

NINE MSN
AAP

Financial markets will track a new staff forecast for 2012 inflation Thursday as a gauge to when the European Central Bank might begin to raise its key interest rate, analysts said.

"In terms of policy implications, watch out for 2012 inflation. The closer this forecast is to two per cent, the higher the chance of an early rate hike," ING senior economist Carsten Brzeski said.

Observers do not expect the rate to break loose from its record low of 1.0 per cent until later this year, but dogged inflation now underpinned by unrest in North Africa is causing some to rethink their forecasts.

In February, eurozone inflation reached 2.4 per cent according to a European Union estimate, and it is likely to rise higher given a spike in oil prices.

"We expect a number of announcements to indicate the tightening cycle is getting closer," Royal Bank of Scotland analysts wrote in a research note.

The Bank of England is believed closer to raising its own key rate from a record low of 0.50 per cent, possibly within the next few months.

Meanwhile, in addition to releasing new 2011-2012 outlooks for growth and inflation, the ECB could revamp exceptional measures taken to ensure commercial banks had ample cash to keep lending to businesses and households.

ECB president Jean-Claude Trichet might announce that unlimited loans for three-month periods will be distributed again via an auction process, which would raise pressure on banks now dependent on the ECB cash.

ECB governing council members have indicated they were working on a solution for such "addicted" banks in peripheral eurozone countries like Greece and Ireland.

The central bank's decisions come against a background of an economic recovery that has favoured core countries like powerhouse Germany while leaving debt-stricken Greece in recession.

The European Commission has raised its eurozone 2011 growth forecast slightly to 1.6 per cent after manufacturing and service activity climbed in February to levels last seen in July 2006 and unemployment fell below 10 per cent in January for the first time since July 2010.

Trichet has said clearly that interest rates could stay on hold to avoid choking off the recovery, even as exceptional measures taken during the global economic crisis are slowly unwound.

ECB policymakers believe that a spike in food and energy prices should not lead to chronically higher inflation, which already exceeds the bank's target of below but close to 2.0 per cent.

But "what is probably more worrying from an ECB point of view, is the underlying pressures mounting," UBS economists said in a research note.

BoAML analyst Silvia Ardagna said: "The conservative approach of the ECB, sometimes criticised for its excessive focus on inflation, could now turn to its advantage."

As for the ECB staff forecasts, analysts expect the inflation figure for 2011 to be raised from 1.8 per cent to around 2.2 per cent, and for 2012, many expect a forecast of around 1.7 per cent.

In terms of growth, the 2011 figure of 1.4 per cent could also be upgraded to about 1.7 per cent, while the number for 2012 could remain at 1.7 per cent.

But Ernst & Young senior economic advisor Marie Diron said: "If oil prices were to stay around $120 per barrel this year and next, growth would be only around 1.0 per cent.

"This would mean significant delays in what was already seen as a slow recovery."

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