Top European Central Bank policymakers on Friday left open the possibility of a bigger than expected rate rise as the ECB's chief expressed dissatisfaction with inflation running above target.
The comments, a day after ECB President Jean-Claude Trichet signalled a rate rise in June, briefly sent ripples through markets with the euro jumping and interest rate futures falling.
Asked about the chance of a half point rise in June, Governing Council member Axel Weber was careful not to encourage such speculation, but neither did he rule out the possibility.
I don't want to be misunderstood, but all options are always open, he said, signalling that the ECB's two quarter point rate rises so far have yet to curb surging liquidity.
I don't really want to speculate, I have said that we are in an environment where we have a very strong liquidity dynamic. It has increased despite the two rate moves, and we have more liquidity than is needed to finance non-inflationary growth, he told reporters at a conference in the German town of Eltville.
Because of that we have to brake the liquidity dynamic and that will play a role in our decisions.
The euro briefly spiked up a quarter of a cent against the dollar to a one-year high after Weber's comments before retreating to trade around $1.2690. On the debt market the June Bund future fell to a session low of 114.90 before recovering, while 10-year euro zone government bond yields hovered close to 18-month peaks.
ECB chief economist Otmar Issing would not speculate on a 50 basis point move in June. But he did say that if economic data confirms the central bank's forecasts for growth of about 2.1 percent this year, the ECB could consider a faster pace.
Such action would not require a strong batch of economic data. Not at all. Not at all, he said.
If after three months, six months, the baseline is confirmed, then you are in a different situation ... When the baseline is confirmed by incoming data, something has changed.
Trichet himself declined to comment when asked whether the Governing Council had discussed the possibility of a 50 basis point rise in June, striding through a crowd of journalists on his way to make a speech to business leaders at the Frankfurt Chamber of Industry and Commerce.
UNHAPPY WITH INFLATION
In the speech Trichet made clear he was not happy with the euro zone inflation rate, which hit an annual 2.4 percent in March -- well above the ECB's 2 percent ceiling. We are of course not satisfied with inflation above 2 percent, he said.
His chief economist Issing made a similar remark on the sidelines of a Frankfurt conference, noting that price stability risks are on the upside -- a point the ECB has consistently made in its monetary policy statements.
However, Issing stressed the ECB has no timeframe in mind for how quickly it wanted to return rates to more normal levels, rather that the pace would be determined by economic data.
We have no fixed target and no fixed calendar, he said.
Traders and economists expect the ECB's Governing Council to raise its benchmark rate by a quarter percentage point to 2.75 percent at the next monthly meeting, encouraged by Trichet's comment on Thursday that the bank was exercising strong vigilance on the inflationary threat.
But with oil prices hitting record levels, they have also raised the possibility that the ECB might increase rates by half a percentage point, which would be the central bank's most aggressive policy tightening in six years.
The ECB is expected to raise rates in June and there is a prospect that they will raise more aggressively than the Fed, which should keep the euro well bid, said Monica Fan, global head of FX currency strategy at RBC Capital Markets.
Economists believe the U.S. Federal Reserve may soon end its almost two-year campaign of rate increases while the ECB, which began only in December, is likely to keep going for some time.
That expectation has in part been driven by recent comments from Trichet that the ECB wanted to normalise euro zone interest rates from the current accommodative position.
Real rates are barely positive and credit growth is roaring along at around twice the pace that the bank believes is consistent with price stability.
Although Trichet did not mention rate normalisation specifically at his news conference on Thursday, one central banker who attended the Governing Council meeting said it remained the intent of the ECB.
It is in the forefront of our minds, the euro zone central banker said, declining to be identified. He also expressed satisfaction with the market response to the ECB's monetary policy intentions.
What is interesting is that markets have priced in remarkably well what the ECB has attempted to communicate with regard to the path toward normalisation.
Another Governing Council member also said that market expectations of a 0.25 percentage point rate rise in June was appropriate. That's about right, he said.
Asked about risks of a 50 basis point move in June -- to which Euribor futures attach a 20-30 percent likelihood -- he said it is necessary to see how the data unfolds, particularly the first quarter GDP growth data due on May 11.
That is absolutely critical, the central banker said.
He was cautious in passing any judgement on whether the underlying dynamic of economic growth had accelerated in the euro zone. Rather he said the GDP data would give guidance on whether the ECB's expectation for 2.1 percent GDP growth this year was unfolding or whether a reassessment is needed.
Weber refused to be drawn on whether the ECB wants to see the first quarter growth data before raising rates. All information is important, we have always emphasised that we have a medium-term orientation ... we base our decisions on all available information, he said.