The European Central Bank sent a strong signal today that it was ready to raise its key interest rates further after already raising them by a full percentage point to 3% since December.
While the ECB held its benchmark refinancing rate steady at 3% at its regular monthly policy-setting meeting today, the bank said it was prepared to raise the rate again in the coming months to keep a lid on inflation in the single currency area.
ECB President Jean-Claude Trichet said that further rate hikes would be warranted in the future if the ECB's assumptions with regard to the outlook for growth and inflation proved correct.
'If our assumptions and baseline scenario continue to be confirmed, a progressive withdrawal of monetary accommodation will remain warranted,' the Frenchman said. There was every indication that the bank's assumptions with regard to the growth outlook would indeed be confirmed, he said.
'The information that has become available since our last meeting has further underpinned the reasoning behind our decision to increase interest rates earlier this month,' Trichet said.
The ECB today also revised upwards its forecasts for both growth and inflation in the euro zone for 2006 and 2007.
According to the regular quarterly projections compiled by the ECB's own staff, inflation in the euro zone was expected to average 2.4% in both 2006 and 2007. Previously the ECB, which sees 2% as the maximum tolerable level of inflation, had expected average annual inflation of 2.3% for 2006 and 2.2% for 2007.
But inflationary risks have increased in recent months owing to persistently high oil prices and accelerating growth in the 12 countries that share the euro, the ECB chief said.
The ECB also raised its euro zone growth forecasts for both this year and next year to 2.5% and 2.1% respectively. Previously, it had been pencilling in growth of 2.1% for 2006 and 1.8% for 2007.
The upgraded forecasts 'mainly reflected the stronger growth recorded in the first half of this year, along with continued positive signals from a number of other indicators,' Trichet explained.
Most of the recent economic data for the first half of the year 'show a significant improvement in underlying economic activity and indicate that economic growth was stronger than previously projected by official and private forecasters,' the ECB chief said.
In face of accelerating growth and inflation, 'strong vigilance remains of the essence so as to ensure that upside risks to price stability are contained,' Trichet said. The term 'strong vigilance' is seen by ECB watchers as the bank's watchword for imminent rate hikes.
'Indeed, acting in a timely manner to contain risks to price stability remains essential to ensure that inflation expectations in the euro area are kept solidly anchored at levels consistent with price stability,' Trichet said.
Only by the anchoring of inflation expectations could monetary policy make a contribution to sustainable economic growth and job creation in the euro area, he added.
At 3%, euro zone interest rates were at their highest level in more than three and a half years, but they remained low in both nominal and real terms, Trichet explained.
Niall Dunne of Ulster Bank said that the key to today's statement lies in Trichet's call for 'strong vigilance' with regards to inflationary pressures, as a call for vigilance has preceded each of the past four rate hikes.
He said today's press conference makes clear that rates will rise again next month, and markets are confident rates will rise to 3.5% (a five-year high) by year-end.
He added that Ulster Bank's view for 2007 is at odds with hawkish forecasts that see rates rising to 4.50% or 4.75% next year.
'Looking to 2007, we see a real risk of rates rising to 3.75%, yet hikes beyond this level seem unlikely, given the ECB's emerging (and seemingly more relaxed) view on money supply growth, and the likelihood that Eurozone economic activity will decelerate in the quarters ahead', he said.