By Simon Kennedy
Aug. 26 (Bloomberg) -- European Central Bank President Jean- Claude Trichet may buy time tomorrow as he seeks to thaw a credit-market freeze without surrendering a two-year fight against inflation.
In his first speech since the financial-market rout began, Trichet may disappoint investors wanting a clear signal whether he will raise interest rates on Sept. 6. He may instead keep his options open, pledging liquidity to the banking system without closing the door on an increase. He speaks at 3 p.m. in Budapest.
``The ECB is far from decided,'' said Michael Hume, chief European economist at Lehman Brothers Holdings Inc. in London. Trichet's speech ``seems too soon to clarify matters.''
A week ago, investors bet that the global contraction in credit would prevent the ECB lifting its benchmark rate from 4 percent. That view is now in doubt after the ECB on Aug. 22 loaned an additional 40 billion euros ($55 billion) to banks and said it was sticking to the policy stance expressed by Trichet on Aug. 2. Then, he promised ``strong vigilance,'' a phrase used to foreshadow each of the eight rate increases since 2005.
Investors reacted by reviving their wagers that the ECB will boost borrowing costs by a quarter point in September. The implied rate on the September interest-rate futures contract rose to 4.57 percent last week from 4.34 percent on Aug. 10.
Forecasts Abandoned
At the same time, some economists have scrapped their forecasts for further ECB tightening.
``Additional tightening from the ECB now risks exacerbating the current crisis and could prompt an even sharper slowdown,'' said James Nixon, an economist at Societe Generale SA in London who used to work as a forecaster at the ECB. ``We now expect the ECB to hold rates at 4 percent until at least the spring of next year.''
There is evidence that the fallout from the collapse in the American market for subprime mortgages is hurting Europe.
BNP Paribas SA, France's biggest bank, was forced to halt withdrawals from three of its investment funds, while Landesbank Sachsen Girozentrale, the German state-owned bank, is getting emergency funding.
UBS AG, Europe's largest lender, said Aug. 14 profit may decline for the rest of the year because of turmoil in financial markets. On Aug. 15, Merrill Lynch & Co. equity analysts cut their rating on Deutsche Bank AG, saying the squeeze in credit markets will reduce earnings.
`Deep Thinking'
The French and Italian finance ministries have urged Trichet to keep rates unchanged.
``We've had a severe deficit of confidence that fueled a liquidity shortage, which will in turn reduce the amount and terms of credit to companies,'' French Finance Minister Christine Lagarde said in an Aug. 24 interview. ``There has to be deep thinking about what is really taking place.''
Whether Trichet, 65, follows through with his August plan to raise borrowing costs will depend on how successful he is in calming market turbulence and ensuring it doesn't curb economic growth. The euro-region economy slowed more than forecast in the second quarter, and a report last week showed manufacturing and services growth slackened in August.
The ECB is already using other tools to smooth inter-bank lending, extending loans and adding 211.3 billion euros of extra cash to the money market between Aug. 9 and Aug. 14.
Should these operations ease investors' concerns, Trichet may be able to keep fighting inflation, said Marco Annunziata, chief economist at UniCredit Markets & Investment Banking in London.
`Crucial Distinction'
The ECB is ``highlighting a crucial distinction: While they are injecting liquidity as a short-term tactical move, their strategic policy stance does not necessarily change,'' Annunziata said.
Robert Lind, chief economist at ABN Amro Holding NV in London, sees reasons for the bank to lift rates regardless of the market rout: Growth remains above potential, spare capacity is shrinking and inflation is likely to accelerate above the ECB's 2 percent limit.
Trichet may also be worried about giving the impression he is prepared to alter monetary policy to rescue investors from risky wagers that went wrong, said Lind. ``The ECB will want to push rates to a more restrictive setting,'' he said.
Trichet has already given himself room to maneuver by noting on Aug. 2 that the council ``never pre-commits'' on rate shifts. Jim O'Neill, chief economist at Goldman Sachs Group Inc. in London, says he'll try not to close off any policy options tomorrow.
``Trichet is quite experienced in crisis management,'' he said. ``He's arguably the most experienced central banker in the world, so he should be able to find the right phraseology.''
