Ocean Tankers forecasts $20 mln 2008 profit Cyprus

The European Central Bank is likely to raise interest rates next month because of worsening inflation, and will do so again if the situation deteriorates further, ECB Governing Council member Athanasios Orphanides told Reuters.

The Cyprus central bank chief described as appropriate market expectations of a rate rise from 4.0 percent in July but said it was too soon to commit to moves after that.

In an interview conducted late on Monday, he also struck a bullish note on economic growth despite data on Monday which was worse than most economists had expected.

"If you look at market expectations for July since the June meeting, they are appropriate. I do not want to go beyond July," Orphanides said in his first interview with an international news agency since Cyprus adopted the euro on Jan. 1.

While the ECB did not precommit to any interest rate path, it was prepared to raise rates further if needed.

"If, for example, we were to receive further adverse news regarding inflation developments, the Governing Council would find it necessary to move in the appropriate direction," he said. "On the other hand, if we had favourable developments on inflation there might be no need for multiple interest rate increases."

His tough comments drove the euro up more than a tenth of a cent against the dollar and also pushed up interest rate-sensitive two-year Schatz yields as traders confirmed bets on further ECB monetary tightening.

Financial market turmoil and an uncertain global economic outlook have forced the ECB to keep rates at 4.0 percent since June last year, despite rocketing oil and food prices which pushed euro zone inflation to a record 3.7 percent in May.

Economists had expected rates to stay on hold for months longer, but ECB President Jean-Claude Trichet shocked markets on June 5 by saying the Governing Council was in a state of "heightened alertness" and that a rise at the ECB's July 3 meeting was possible, although not certain.

Financial markets are pricing in about a 90 percent chance of a move to 4.25 percent on July 3 and investors generally expect rates to hit 4.5 percent by the end of the year.

Orphanides said above-target inflation, and the risk of it shaping the public's longer-term price expectations, was the ECB's main worry, whereas growth should steadily recover after a sluggish second quarter.

"I personally expect growth in Q2 to be weaker than growth in Q3 and Q4. The weakness that we probably see in the second quarter is not one that I expect to see for the rest of the year," he said.

"Growth continues to be proceeding at a satisfactory rate in the euro area. It's true that the baseline scenario for the growth rate is that growth will be weaker than last year, but I don't see that as particularly worrisome."

ECB staff project euro zone growth of around 1.8 percent this year and 1.5 percent next year, below 2007's 2.6 percent and the 15-nation bloc's long-term trend rate of just over 2 percent.

Orphanides, in line with Trichet, predicted a return to near trend growth by the end of 2009.

BULLISH BERNANKE

The solid picture was unchanged by Monday's purchasing managers' data, he said. This was worse than economists expected and showed the euro zone manufacturing and services sectors both contracting for the first time in five years.

"The question is if this is surprisingly bad data. This data is worse than some analysts expected, but I also pointed out that I expected Q2 to be weaker than Q1 and that I don't expect this weakening to continue," Orphanides said.

"I don't think we have had a significant enough revision in the outlook to influence the path for monetary policy. Instead I would draw your attention to the latest inflation numbers."

Orphanides, who worked at the U.S. Federal Reserve until taking the helm of Cyprus's central bank last year, noted that Fed Chairman Ben Bernanke was positive about the U.S. economy even in the face of a much more significant slowdown than in the euro zone.

"Despite the surprisingly large upward change in the unemployment rate, he was rather optimistic about the prospects of the U.S. economy going forward," he said, citing a June 9 speech by Bernanke.

The worst of the financial market turmoil sparked by the U.S. subprime crisis was probably over. But it was very unclear how long it would take interbank lending rates to fall, potentially slowing euro zone growth by pushing up private-sector financing costs, Orphanides added.

OUT-DATED PROJECTIONS

Rising oil prices meant the ECB's staff inflation forecasts for this year, updated just a few weeks ago, already looked too low, Orphanides said.

ECB staff raised their inflation forecasts to around 3.4 percent for 2008 and 2.4 percent in 2009 -- versus a target of just below 2 percent. This was based on assumptions of oil prices averaging $113.3 a barrel and three-month interbank lending rates at 4.9 percent.

Oil now costs over $136 a barrel while three-month rates fixed at 4.958 percent on Tuesday.

Orphanides said he expected year-on-year inflation to fall below the ECB's ceiling of 2 percent in the second half of 2009, but declined to comment further due to the uncertainty of oil price and financial market moves.

The key risk was that the public would not view current high inflation as temporary, and instead that businesses and workers would make it permanent by passing on higher raw material costs and demanding compensation for the higher cost of living.

But so far there was not enough data to show that medium-term inflation expectations had risen, Orphanides said. "The way I read inflation expectations so far is that they have stayed well-contained."

"The ECB will try to do what is necessary to achieve price stability over the medium term. We take that very seriously. We watch inflation expectations very seriously as that is a very good indicator -- albeit with the imperfections certain measures have -- of the need for ECB action."

A European Commission survey asked only about shorter-term inflation expectations. ECB analyses produced mixed verdicts on whether an apparent rise in break-even inflation rates for index-linked bonds was due to rising price perceptions or technical factors, Orphanides said.

Orphanides was equivocal when asked if the phrase "heightened alertness" in ECB statements would take on the role of "strong vigilance" -- previous code words signalling there would probably be a rate rise the next month.

"That is an oversimplification. What you can infer is that it was deemed the right phrase in June and that it was deemed advantageous to avoid using precisely the same words as were used in a different environment to the current one." (Reuters)

By Financial Mirror , 25/06/2008|||Cyprus ECB member warns of rate hike in euro rates
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