By Johanna Treeck

HELSINKI (MNI) – European Central Bank President Jean-Claude
Trichet on Thursday signalled that the ECB will likely keep a steady
hand next month but went out of his way to keep maximum flexibility for
the bank’s future policy course.

The market, on balance, had anticipated another pause in June after
today’s expected ECB decision to keep rates unchanged in May. But it was
a very close call after headline inflation surged more than expected to
2.8% in April and pipeline price pressures continued unabated.

Indeed, many market participants had expected Trichet to signal a
June rate hike today by uttering the words “strong vigilance.” When he
failed to say them, the euro dropped like a stone to $1.4677 from
$1.4824 and June Bunds rallied.

The Eonia swap curve also pushed back rate hike expectations after
Trichet spoke, almost completely ruling out a June hike and no longer
fully pricing in a move in July as it had before today’s press
conference. At the close of business in London Thursday, the market was
no longer fully discounting the next rate hike until September, with one
to follow in December. Before the press conference, that followup
increase had been fully discounted for October.

This dovish market interpretation of Trichet’s comments, however,
may well not be justified.

Trichet certainly kept his cards close to his chest regarding the
timing of future interest rate hikes. On the one hand, he insisted that
the ECB is not in a “normalization” mode, suggesting that it is not
pre-committed on another rate hike.

On the other hand, he left the door open even for a rate hike in
June by reminding markets that the ECB does not shy away from surprising
markets with unexpected rate hikes. “In March, market expectations were
that we would not increase rates at any moment in the year,” he
recalled. Then, “the Governing Council came and said ‘We are in a
posture of strong vigilance’.”

While the absence of “strong vigilance” does indeed make a June
rate hike unlikely, the wording of the introductory statement suggests
that the pause will not be very long. Interest rates are still
“accommodative”, risks to the inflation outlook still “remain on the
upside,” and the ECB will “continue to monitor very closely” these
risks.

Asked about expectations for two more rate hikes this year, Trichet
responded, “I have no other comment on market expectations which would
go against the present expectations.” Again, this suggests that the
central bank cannot hold off tightening for much longer. It may help to
explain the absence of “strong vigilance” today.

A signal for a June hike would have been widely interpreted as an
intention to raise rates every two months, ending the year at 2.0%,
which is perhaps faster than the Council itself envisions at the current
juncture. Why unnecessarily drive up the euro and further undermine
already-softening confidence and economic activity in the Eurozone given
“elevated” uncertainty?

The results of the Survey of Professional Forecasters — showing
inflation expectations very well anchored — is also likely to have
played a key role in the Council’s decision not to signal a rate hike
for June, although the price stability environment clearly continues to
deteriorate.

The central bank’s credibility is ensured by its track-record and
the fact that the ECB was the first major industrialized-nation central
bank to have hiked rates, Trichet said. “As regards our credibility, let
me only mention that being the first big central bank in the world to
increase rates, I don’t think that, from that standpoint, we have any
credibility problems.”

The ECB will be careful not lose this hard-won credibility. In
June, the central bank will almost certainly present 2011 GDP staff
forecasts for inflation that are revised significantly upward. Doing so
without signaling a readiness to respond promptly with policy action
could weaken its credibility. This, again, would seem to suggest that
“strong vigilance” will not be missing next month.

On the non-standard measures liquidity, Trichet did not provide any
real new insights. He said that the liquidity framework going forward
had not even been discussed at today’s meeting. As a senior Eurosystem
official told MNI, the Council is “waiting for the results of the stress
tests to see the state of the banking system, and exploring targeted
liquidity facilities is one of the options we are discussing.”

Persistent reminders by Trichet that the ECB’s monetary policy is
“completely separate” from its non-standard measures, coupled with weak
bank lending data, may suggest that the fixed-rate full-allotment
procedure will remain in place for at least some of the bank’s refi
operations well beyond June.

On the Securities and Markets Program, Trichet once again said he
had nothing to add to the published weekly data on bond purchase volume.
Over the last five weeks, this data has showed that the ECB stopped
intervening even as bond spreads continued to spiral. Trichet’s
insistence that the data speak for themselves, however, may suggest that
the ECB does not plan to officially close the facility even if it
remains inactive.

While the ECB for now has stopped supporting peripheral countries
through the purchase of their debt, Trichet did offer some verbal
support.

He exhorted Greece to implement fully its austerity plan and sought
to quell recent rumors and reports that Greek debt might be
restructured. “We consider it is not in the cards,” he said. His comment
was a much stronger rebuttal to the debt restructuring talk than he had
offered in previous appearances.

Trichet also endorsed the recently agreed E78 billion bailout
package for Portugal, and he expressed the ECB’s solidarity with Ireland
in the strongest possible terms. Of course, Trichet insisted that these
countries stick to their ambitious consolidation programs and implement
the EU/IMF plans.

He also made clear that the need for fiscal austerity was not
applicable to these countries alone. “I have been very clear that our
message on fiscal policies was a message that was going to all countries
— Greece, of course, among others,” Trichet said.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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