BoI forecasts ECB rate of 3.75% in 2007

Bank if Ireland's chief economist, Dr Dan McLaughlin, has announced that in light of bank lending in the euozone, he is changing his forecast for ECB rates and expects the repo rate to rise from 3.5% in December to 3.75% in March 2007.

Dr Dan McLaughlin said: “It would now come as a major shock to the financial markets if the December 7th meeting in Frankfurt did not deliver another quarter point increase in the repo rate, as that was clearly signalled at the last policy meeting in early November.

"This would take the repo rate to 3.5% and bring the total rise in the past twelve months to 1.5%.

“There is more uncertainty about the likely path of rates beyond December, although the financial markets are now fully pricing in a repo rate of 3.75% by the spring. Economic growth in the euro area did slow in the third quarter, to 0.5% from 0.9% in Q2, but this was from elevated levels and still left the economy growing at a pace around its long term trend.

"This might argue for higher rates, particularly as monetary policy is still ‘accommodative’ and there are few signs from the most recent data releases of any imminent slowdown in Europe - indeed, German business confidence in November stood at a 15-year high.

"The US economy, in contrast, did slow sharply in the third quarter in the wake of a steep correction in the housing market, and this uncertain outlook for the US poses a risk for eurozone growth in 2007 and 2008, but one doubts if the ECB will build in to their forecasts anything other than a relatively benign global backdrop.

"The recent weakness in oil prices also provides food for ECB thought, as it helped propel eurozone inflation down to 1.6% in October, from 2.5% in June. A weaker profile for oil prices argues for a lower inflation trend than expected a few months ago, but this, in turn, may help to boost consumer spending and hence bolster economic growth in the coming year, so the implication of lower oil prices for interest rates is ambiguous.”

He concluded: “What is clear though, is that the monetary tightening seen to date has yet to influence credit creation or monetary growth, as both are growing at a pace which is a concern for the ECB. The latter re-accelerated over the summer months, and bank lending to companies and consumers is growing at 11.4% per year, the strongest pace since the euro was introduced. It is true that mortgage lending has slowed marginally, which the ECB would welcome, but one doubts if the Governing Council would be comfortable signaling that rates are appropriate in the absence of some slowdown in the pace of bank borrowing. On that basis, we are now changing our forecast for ECB rates, in the light of these monetary developments and in the face of hawkish rhetoric from the Bank: we now expect the repo rate to rise from 3.5% in December to 3.75% in 2007, with March seen as the most likely month for the latter move.”