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March 30, 2006

German Ifo and Euro-zone M3 Boost Odds of May ECB Rate Hike
by Victoria Marklew

Key data releases this morning have the markets upping their bets on the European Central Bank hiking interest rates on May 4, rather than waiting until June 8 - and with good reason.

The German Ifo institute's business sentiment index for March unexpectedly shot up by two full points, to 105.4 - a whopping 15-year high. The overall index was pushed upward by higher readings in all its components - manufacturing, construction, wholesaling and retailing. The current business conditions index jumped from 101.9 in February to 105.1 in March and the forward-looking expectations index climbed from an upwardly-revised 104.9 (prev. 104.8) to a heady 105.7.

Meanwhile, Euro-zone M3 money supply growth continued to accelerate in February, the seasonally-adjusted annual increase reaching 8.0%, up from 7.6% in January. Mortgage-related borrowing rose an annual 11.8%, the same pace as the upwardly-revised January rate, helping to boost annual growth in loans to the private sector to 10.3% (9.6% in January). Past ECB tightening clearly had no dampening impact on loan demand.

Germany's ECB Governing Council member Weber this morning noted the "strong dynamics of credit and counterparts of M3 growth" that support the ECB's view "that M3 growth is increasingly driven by the low level of interest rates." And today, in a letter to a member of the European Parliament, ECB President Trichet specifically noted that "the buoyant loan and house price developments in the euro area warrant close and continued monitoring, not least as they could imply a risk of price misalignments."

There is little chance of an ECB rate hike on April 6. Under Trichet, the ECB has made it a point not to spring surprises on the markets (unlike the former German Bundesbank). The comments from Trichet and co. have yet to be quite as pointed as in the weeks immediately preceding the last two rate hikes. Rather, the April 6 statement and subsequent speeches likely will be used to prepare the markets for a May 4 rate increase. In particular, look for Trichet and others to start using the word "vigilant" again - the sooner they do so, the more likely that the hike comes in May.

As we have noted before, policy interest rates are headed upward across the major markets of continental Europe, and are at least on hold in the UK. Various unrelated domestic political jitters are causing unease in some of the high-yield markets around the world - Brazil, Iceland, Poland, Thailand, Turkey. Today's data will cement expectations of higher interest rates in Europe and add to the momentum of bearishness toward such markets. Ultimately, however, the US Fed remains the global policy-maker to watch.

Victoria Marklew
The Northern Trust Company
Economic Research Department
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675

The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.

Copyright © 2005-2008 The Northern Trust Company

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