Markets expect tough European bank inflation talk

FRANKFURT (AFP) – Financial markets expect tough talk on inflation from European Central Bank president Jean-Claude Trichet but the ECB's main interest rate is set to remain at a record low of 1.0 percent.

A centre of focus when Trichet speaks following the rate decision will be on an updated forecast by central bank staff for 2012 inflation.

Economists say its level with respect to the ECB target of just below 2.0 percent will give a good indication as to when the bank's key lending rate could begin to rise from the level it fell to in May 2009.

With eurozone inflation at 2.4 percent, a growing economy, producer prices on the rise and Arab unrest pushing energy costs higher, ECB policymakers might have to rethink their view that price stability will return in early 2012.

Credit and the money supply are also rising, the Bank of England could soon raise its rate from the current low of 0.50 percent and the European Union might not get to grips with the eurozone debt crisis later this month.

If EU leaders do not agree on terms that ease market pressure against Greece, Ireland and Portugal, the ECB could find itself in a bind.

The bank would have to keep buying government bonds and the threat of a rate hike to press for fiscal discipline could make things worse for the weaker peripheral eurozone countries.

Global Economics economist Julian Jessop noted however that due to a surge in oil prices, "there is clearly a risk that the Bank of England or the ECB decide to raise rates sooner than they would otherwise have done."

The ECB's March meeting will be marked by new staff forecasts for growth and inflation, and possibly "important decisions on the liquidity strategy" aimed at helping struggling commercial banks, UniCredit economist Marco Valli said.

So-called "addicted" banks must be taken off an ECB drip of cheap loans as part of the central bank's move towards an exit from exceptional measures taken to battle the global economic and financial crisis.

One possible decision would be to end unlimited three-month loans and force banks to bid again for the funds.

But as fresh risks might emerge with a new and tougher set of bank stress tests, "for the ECB the cost of waiting and extending the full allotment for at least a couple more months seems to be lower than the cost of moving towards a less generous liquidity provision system," Valli said.

Trichet has said the ECB could act on either interest rates or liquidity measures while leaving the other unchanged, but analysts think he will begin by raising "hawkish" anti-inflation rhetoric.

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

As for the staff forecasts, analysts expect the inflation figure for 2011 to rise from 1.8 percent to around 2.2 percent, and for 2012 many tip a forecast of around 1.7 percent, up from the current estimate of 1.5 percent.

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

The European Commission raised its eurozone 2011 growth forecast slightly to 1.6 percent this week after unemployment fell below 10 percent in January for the first time since July 2010.

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