Geopolitical factors won’t stop ECB rate hike, say analysts

Analysts have said uncertainty surrounding the geopolitical environment is unlikely to delay the European Central Bank (ECB) from raising rates at its next monetary policy meeting in April as widely expected.

The ECB's hawkish policy announcement after its last meeting on March 4, was viewed by markets as paving the way for a quarter point rate hike in April, taking the benchmark main refinancing rate to 1.25%. Jean-Claude Trichet, the president of the ECB, said "strong vigilance [was] warranted" against upside risks to price stability, a phrase that has in the past been used to herald tightening cycles. The harmonised index of consumer prices inflation climbed 0.1 percentage points to 2.4% in February. However, ECB staff said these projections left out the most recent round of commodity price increases resulting from the political tumult in the Middle East.

Uncertainty over the pace of global recovery in the wake of the devastating earthquake on Japan's north-east coast and continued political unrest in the North Africa and Middle East region have led some to speculate that central banks may delay any monetary policy tightening. However, these events have not stopped other advanced economies from normalising policy rates, with the Bank of Israel on Monday announcing it had raised its benchmark interest rate by 0.5 percentage points to 3%. Although the earthquake and tsunami in Japan and political turmoil in several Arab countries had cast a shadow over forecasts for global growth, the central bank said it expected the effects of most of the shocks to be "temporary".

This was a view also held by James Bullard, the president of the St Louis Federal Reserve. Bullard said on Tuesday the Federal Open Market Committee "may not be willing or able to wait until all global uncertainties are resolved" to begin normalising policy and that the most likely prospect was that "[the global uncertainties] would be resolved without becoming global macroeconomic shocks".

Analysts said recent comments from the ECB suggested it remains concerned about building inflationary pressures and that it would continue to plan for a hike in interest rates in April. "The Euroland economy is holding up well in the face of recent external shocks and inflation has been above the ECB's 2% upper target range recently," Nick Stamenkovic, a strategist at brokerage RIA Capital Markets, told CentralBanking.com. "The current level of nominal rates is not appropriate despite ongoing tensions in some peripherals. Indeed, a host of ECB members have signalled that a monetary tightening is on the cards in April," he said.

Nick Matthews, an economist at RBS, agreed. However, he said whether the ECB raises rates could depend on conditions on the day of the rate decision. "Obviously there have been some significant developments since the ECB put markets on alert to a rate hike, with rising geopolitical tensions in the Middle East and North Africa and the tragic Japanese disaster. But I think we would need to see stock markets and oil prices much weaker to impact the ECB and prevent a rate hike," Matthews said.

However, Chris Whelan, a senior broker at MF Global, said he believed Trichet's use of "strongly vigilant" rather than "extremely vigilant" was made to give the ECB some room for manoeuvre. "If he'd said extremely then we'd have expected 100% a rate hike next week. Strongly suggests they might pause till May," Whelan said.

The Governing Council next votes on 7 April.