Italy feels heat as Trichet moves to cool eurozone

By Stewart Fleming

Date: 09/03/06

Hints from the European Central Bank (ECB) of future interest rate increases will be discussed by finance ministers of the eurozone when they meet in Brussels on Monday (13 March).

Last week (2 March), Jean-Claude Trichet, president of the ECB, pushed the bank's key rate up again, to 2.5%.

His report of the mood in the ECB governing council provoked predictions from financial market economists that at least one and possibly three rate increases of 0.25% were on the cards for later this year.

Whereas last December the Eurogroup chairman Jean-Claude Juncker challenged the wisdom of the ECB's decision to raise rates, last week the eurozone finance ministers kept quiet.

But the ECB's plans are most problematic for Giulo Tremonti, finance minister of Italy. The government of which he is a member is facing an election next month, only weeks after the country's statistics agency announced that the Italian economy failed to grow last year. An expected first quarter revival is unlikely to be sustained. Rises in ECB interest rates will not be what Tremonti wants for his increasingly uncompetitive country.

Trichet said that future rises in interest rates would be dependent on the economic data, which is unlikely to reassure Eurogroup finance ministers, especially after Jean Philippe Cotis, chief economist of the OECD, called this week for a pause until "there are unambiguous signs that [economic] slack is shrinking and that underlying inflation pressures are mounting".

The ECB has just tweaked its growth forecasts for 2006 and 2007 up a sliver to 2.1% and 2.2%, following an unexpectedly weak fourth quarter of 2005, and most private economists are pencilling in a steady economic recovery this year. The ECB also expects inflation to remain above its 2% monitoring range through 2006 and 2007, strengthening its case for "vigilance".

The biggest problem with such predictions is that, so far, they are based not on hard data but on 'lead indicators' such as surveys of business and consumer confidence. The widely followed Ifo index of business confidence in Germany, for example, has just hit its highest level since the Germany reunification boom of the early 1990s, consistent, historically, with growth rates of 4-5% according to Christel Aranda-Hassel of Credit Suisse.

So, despite predictions that export-led growth and the sanitisation of corporate balance sheets are transforming into rising investment in the eurozone (the ECB's expectation) and that this will lead to that elusive rise in consumer spending, the hard data is not there yet to prove that this is happening in the real world. Michael Dicks of investment bankers Lehman Brothers insisted that the eurozone recovery was "still fragile". This is not, he said, the sort of "job-rich" recovery which automatically tends to boost consumption. Wage growth remains muted in spite of sabre-rattling by the German trade union IG Metall.

Eurogroup finance ministers will be using these arguments to try to persuade Trichet that he must mean what he says when he promises to wait for the data before increasing rates again.

• At their meeting on Tuesday (14 March), EU finance ministers will decide whether to put more pressure on Germany under the Stability and Growth Pact, demanding that it bring its deficit under the EU's benchmark level of 3% of gross domestic product.

But in effect the decision is a painless one for Berlin as it shies away from the part of the pact that would force the deficit below 3% within one year, instead giving the government until 2007. Germany asked for the extra time as it will raise VAT rates next year and the economy is expected to be stronger.

Author takes a look at the European Central Bank's decision on 2 March 2006 to raise interest rates and the possible impact on Italy's Parliamentary election in April 2006. Article also previews the Ecofin Council meeting on 14 March 2006 where ministers were to decide whether to put more pressure on Germany under the Stability and Growth Pact, demanding that it bring its deficit under the EU's benchmark level of 3% of gross domestic product.