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Highlights
As expected, the European Central Bank kept its policy interest rate at 4 percent. The Bank remains in neutral and is determined above all to keep inflation expectations anchored and not to permit second round effects from taking place. The HICP, after easing to an annual increase of 3.3 percent in April, jumped once again to 3.6 percent in May. The HICP remains considerably above the ECB inflation target of 2 percent. And M3 money supply growth, the second of the ECB's monetary pillars, is more than double its reference value of 4.5 percent. But there are signs of slower growth. For example, business confidence in Germany, Belgium and France all dropped as did the European Commission's economic sentiment index. And retail sales have disappointed as well.
Economic data for individual EMU states varies. The strength of the German economy in the first quarter greatly reduced the pressure on the ECB to lower interest rates. But with inflation uncomfortably above target, the more hawkish members of the governing council might see it as providing the room required to tighten policy. However, with orders slowing quite sharply now, it is highly unlikely that investment will continue to bound along at anything close to the pace seen last quarter. Meantime, with business confidence waning, the surge in inventories will probably serve to depress output in the current period and the abnormally large jump in government spending will likely prove to be a one off. Exports and imports will both probably slow this quarter likely leaving the impact of net trade little changed.
The key to the outlook resides with the household sector and here there is little sign of any bounce. Minimal growth at the start of the period looks increasingly likely to have set the tone for the whole year.
As always, analysts will scrutinize ECB president Jean Claude Trichet's press conference and especially the key first paragraph and question-and-answer session. The chances are that Trichet will keep up his jawboning against inflation risks, suggesting that the ECB is much more concerned with price developments than with downside risks to the economy.
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