Market Awaits Trichet

Today, the ECB decided on interest rates and kept rates at a record low of 1%. We now await the press conference with ECB President Trichet for further clues on ECB monetary policy.

The ECB is the first out of the gate to have a meeting since the recent spike in oil prices. Inflation has already been a hot topic before the previous ECB meeting as the annual inflation rate rose above the 2% target in December 2010. Inflation is currently running at 2.4%.

Of course in the last month, markets have seen an oil shock on the back of the events in North Africa - but mainly in Libya. US light crude contracts for oil prices have moved to $100, while Brent crude - traded on the Intercontinental Exchange - have hit as high as $120.

As a result of worry about elevated commodity prices, recent comments from ECB officials have set a hawkish tone, and have caused many analysts to move up their predictions for when the ECB may raise interest rates.

Last month, the expectation was the end of this year, perhaps December as the target for the first ECB rate hike. The financial press are now stating that bets are being made that August will be the month. That moves up an ECB rate hike by 4 months.

For more on ECB officials comments, see some of our past articles:

Feb 28th - EUR/USD Jumps to 3-Week High as Traders Focus On Interest Rate Differentials
Feb 22nd - Euro Gets A Big Boost From ECB Member Mersch's Comments on Inflation
Feb 21st - A Myriad of Factors to Consider for the EUR - Sovereign Debt Concerns, Oil & Inflation, and Rate Expectations
Feb 18th - EUR Climbs Higher in Choppy Upmove, ECB Member Smaghi's Comments Regarding Rates Reverse Overnight Losses
Feb 8th -EUR/USD Bounces Off its Recent 2-Week Lows on ECB Council Member Mersch's Comments
Feb 3rd - Trichet Says ECB In No Hurry to Hike, EUR Stumbles Across the Board

Rate Differential Story Continues to Support EUR

These changing interest rate expectations have helped support the EUR against the USD during the past month. We have climbed to a 4-month high at the 1.3850 area, but now markets will ask the question if Trichet's comments today match the rhetoric we heard from the other ECB board members.

The bank will be releasing updated inflation statistics which can also help us to decipher how the ECB sees the inflation threat. Yves Mersch, said the ECB may raise its 2011 inflation estimate to more than 2% from 1.8%, and judge that risks to the outlook to inflation have moved to the upside.

From Bloomberg: Investors last week increased bets on the ECB raising rates as soon as August after policy makers including board member Juergen Stark said they will act if needed to prevent soaring commodity prices from driving up price expectations. Trichet must balance those inflation concerns against the risk of exacerbating Europe's sovereign debt crisis by removing stimulus too soon. In addition to keeping rates low, the ECB is lending banks as much cash as they want and buying government bonds...

Trichet may say whether the ECB intends to resume its exit from non-standard policy measures. It has so far pledged to keep offering banks unlimited amounts of cash in its weekly and three-month refinancing operations through the first quarter.

The question of exit strategy will be key. With the sovereign debt crisis still not resolved, and the economic recovery still shaky on the periphery of the Euro-zone, does the ECB have scope to raise interest rates without chocking off growth? Can they remove their unlimited support of banks? With the economy in recovery and inflation becoming a bigger and bigger issue, the ECB may decide its time.

Trichet has to walk a fine line today and the reaction in the market will be to decide if his worry is inflation or chocking off growth. The ECB has been much more willing to act on inflation than other central banks, so Trichet will try to satisfy inflation hawks. However,  too hawkish a reaction may dampen enthusiasm for the Euro-zone recovery.