PREVIEW: ECB to deliver rate hike despite Greek debt concerns

By Andrew McCathie Jul 5, 2011, 10:12 GMT

Berlin - The European Central Bank (ECB) is expected to deliver its second rate hike in four months on Thursday when it raises the cost of money in the 17-member eurozone to 1.5 per cent.

With the Greek parliament having backed Athens' 78-billion-euro (113-billion-dollar) austerity plan, the ECB now seems to have room to move to increase the cost of borrowings to head off the economic risks posed by the reemergence of inflationary pressures.

'I think that the approval of the Greek package means that the path is clear for the normalization of ECB interest rates,' said Klaus Baader chief European economist at Societe Generale.

Speaking to lawmakers in the European Parliament last week, ECB president Jean-Claude Trichet once again signalled that the Frankfurt-based bank would follow up the 25-basis-points increase it announced in April with another quarter-point rise on Thursday.

The ECB chief told the European Parliament's committee on economic and monetary affairs that the ECB was in 'a state of strong vigilance.' This is ECB code signalling that a rate hike is in the pipeline.

At 2.7 per cent, annual eurozone inflation currently stands well above the ECB's 2-per-cent limit. 'A 25-basis-point interest rate hike on Thursday should be a done deal,' said Danske Bank economist Anders Moller Lumholtz.

Eurozone finance ministers agreed on the weekend to the release of 12 billion euros in aid provided under Greece's original 100-billion-euro bailout after the parliament in Athens backed Prime Minister George Papandreou's austerity program last week.

But along with the bank's plans for interest rates in the coming months, ECB President Jean-Claude Trichet is likely to again face a barrage of questions at his regular press conference Thursday on the Greek debt crisis.

This follows the US credit rating agency Standard & Poor's announcement on Monday that a plan proposed by French and German banks to roll over Greek debt could trigger a selective default for Greece.

The rating agency's statement raises the question of whether Greek debt could be rejected as backing for ECB loans and possibly spark a banking crisis in the heavily indebted nation.

Greece's banks are dependent on ECB loans. The ECB has, however, previously ruled out accepting bonds with a default rating as collateral.

The Standard & Poor's move also comes in the buildup to next week's meeting of eurozone finance ministers, which is due to start pulling together a second bailout for Greece that should include private international banks.

In the meantime, signs have continued to point to the European economy slowing in the wake of the economic fallout from Japan's earthquake in March as well the surge in oil prices during the first four months of the year.

But beyond this week's widely expected rate rise, slowing growth and the eurozone debt crisis mean that analysts are divided about the ECB's monetary plans for the coming months.

Many analysts see rates climbing to between 2 and 2.5 per cent by the middle of next year as the ECB presses on with its rate-hiking cycle.

Some analysts, however, have doubts about how aggressive the ECB can be in hiking rates.

The ECB's latest staff projections also point to consumer prices edging up to 2.3 per cent this year before sliding back to 1.7 per cent in 2012.

This would bring consumer prices down to essentially in line with the ECB's target of close to but below 2 per cent.

'We think that July's increase may well be the last in the cycle,' said Jennifer McKeown, senior European economist with the research group Capital Economics.

Still, the ECB has not appeared too concerned about the Greek debt crisis when drawing up plans for tightening monetary policy. Instead, the ECB has been keen to shore up its anti-inflation credentials.

Trichet first raised the prospects of this week's expected rate rise at his press conference one month ago when he also told reporters that the bank was exercising 'strong vigilance.'

This came just as European leaders were struggling to haul Greece back from the brink of a catastrophic default.