Recent data releases and comments from European Central Bank policymakers confirm the view that the ECB will hike the refi rate 25 basis points next week, to 2.50%. Although the Euro-zone's Q4 GDP data was a little rocky, the growth outlook for 2006 remains relatively upbeat. More to the point, the ECB continues to focus on the need to counter inflationary pressure from high and volatile energy prices and from fast credit growth. After easing somewhat in the final months of 2005, the annual increases in both headline CPI and in M2 are back on an upward trajectory.
As expected, the Euro-zone economy hit a bit of a rough patch in the final months of 2005, with Q4 GDP rising just 0.3% on the quarter, down from 0.6% in Q3. In Germany, healthy exports could not counter still-weak consumer demand, leaving GDP in that country flat, after 0.6% growth in Q3. In France, the second-largest Euro-zone economy, overall GDP managed 0.2% quarterly growth, but this was down from 0.7% in Q3. However, data for the first weeks of this year are looking more healthy. As we noted last month, business sentiment is picking up strongly in Germany, and both business and consumer morale has picked up in France and in Italy so far this year.
More telling for the Euro-zone outlook is what has been happening with the Belgian business confidence index - a leading indicator for the Euro-zone as a whole thanks to Belgium's strong trade ties with its neighbors. The index has climbed fairly steadily since Q2 2005, and jumped to +1.5 in February, its highest point in 19 months and up from -2.9 in January.
Meanwhile, ECB Governing Council members have been reiterating that their focus is on medium-term prospects for price stability, that economic growth should pick up, and that inflation risks remain high. Trichet told the European Parliament on Monday that markets are "perfectly sensible" to price in a quarter point rise in the refi rate on March 2. For all of the reasons mentioned above, it seems safe to assume that two more hikes will be forthcoming this year.
