The European Central Bank signalled a July interest rate rise and raised the stakes on Thursday in its stand-off with governments over a new bailout for Greece by rejecting any form of debt restructure. ECB President Jean-Claude Trichet said the bank would exercise "strong vigilance" on inflationary pressures, deploying a phrase that has consistently been used in the past to signal a hike was a month away.
Trichet used precisely that code in March to flag an April rate rise to 1.25 from 1.0 percent, which was the ECB's first tightening in two years. "On balance risks to the outlook for price stability are on the upside, accordingly strong vigilance is warranted. On the basis of our assessment we will act in a firm and timely manner," Trichet told a news conference after the ECB kept its main refinancing rate at 1.25 percent.
Trichet said evidence since the ECB's May meeting confirmed "continued upward pressure on overall inflation mainly owing to commodity and energy prices". But wary of choking off support too fast, the ECB would continue to provide banks with unlimited liquidity to support the recovery, he said.
The euro initially rose on Trichet's comments before retreating, with analysts saying a hike in July had already been priced in. Worries about a lack of unity of response to debt problems in Greece also dented sentiment. Firming cost pressures - euro zone producer prices rose by more than expected in April and headline inflation was 2.7 percent, well above the ECB's target of close to but below 2.0 percent - had convinced most investors more policy tightening was on the way.
"The ECB left little doubt that it will hike its key interest rate from 1.25 percent to 1.50 percent at its July meeting," said Howard Archer, economist at Global Insight. Beyond July, Trichet left the ECB's options open, saying: "We are not signalling any particular pace for the next decisions on our interest rates."
While it flagged a July rate rise, the ECB remains careful not to withdraw support to the economy and banking system so fast as to stall the recovery or endanger banks' ability to cope with limited liquidity. Fears that the eurozone debt crisis might spill over to the banking system and the fact that banks in bailed-out eurozone states remain shut out of credit markets, prompted it to offer unlimited liquidity to banks until at least October.
"(The ECB) today also decided to continue conducting its main refinancing operations (MROs) as fixed rate tender procedures with full allotment for as long as necessary, and at least until the end of the ninth maintenance period of 2011 on 11 October 2011," Trichet said. Previously, the ECB had committed to keeping tenders on an unlimited funding basis until at least July 12, meaning a decision was due. New ECB staff forecasts projected 2011 inflation in a 2.5-2.7 percent range, falling back to 1.1-2.3 percent in 2012.