Euro: Alternatives for the ECB

A 25bp interest rate hike by the European Central Bank on Thursday has been completely priced into the market, but there are increasing signs that the central bank may have to raise interest rates beyond July.

The estimate for Eurozone consumer prices for the month June is 4 percent, double the ECB’s 2 percent inflation target. This spike in inflation complicates the central bank’s task on Tuesday. Up until now the ECB has openly hinted that a rate hike in July will one-off, but with inflation pressures continuing to increase, can they really increase interest rates by only 25bp this year? Probably not. We believe that Trichet is mulling over 2 additional alternatives for Thursday. He could proactively clamp down on inflation by raising interest rates 50bp or he can raise interest rates by 25bp and leave the door open for another rate hike this year. Closing the door completely could be mistake especially if oil prices continue to rise. German retail sales and employment numbers are due for release tomorrow. Given the sharp drop in the retail PMI index, consumer spending in Germany should remain weak. Swiss PMI is also due for release. The dovish comments from the Swiss National Bank suggest tepid manufacturing activity.