European Money-Supply Growth Slows Less Than Forecast

By Gabi Thesing

Aug. 28 (Bloomberg) -- European money-supply growth slowed less than economists forecast in July.

M3 money supply, which the European Central Bank uses as a gauge of future inflation, rose 9.3 percent from a year earlier after increasing 9.5 percent in June, the Frankfurt-based bank said today. That's the weakest growth since November 2006. Economists expected the rate to decline to 9 percent, the median of 26 forecasts in a Bloomberg News survey shows.

``Money-supply and loan growth to corporates is not coming down fast enough for the ECB's liking,'' said Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Plc in London. ``The bank will see it as confirmation that domestic inflation pressures still persist and its next move is more likely to be a hike than a cut.''

While ECB President Jean-Claude Trichet said on Aug. 7 that the nine interest-rate increases since December 2005 had contributed to a slowdown in money-supply growth, he added that ``the strong underlying pace of monetary expansion'' still signals inflation risks. Policy makers kept the benchmark rate at 4.25 percent this month, a seven-year high, on concern that inflation running at twice the ECB's limit may push up wages and prices.

M3 is the broadest gauge of money supply and includes cash- in-circulation, some forms of savings and money-market holdings. The M3 growth rate has exceeded 4.5 percent, the level the ECB still deems non-inflationary, every month since May 2001, reaching a 28-year peak in October

Inflation Risks

The three-month average of the M3 growth rate fell to 9.6 percent from 10 percent, the ECB said. Loans to the private sector grew 9.4 percent in the year, down from 9.9 percent growth in June. The annual growth rate of M1 weakened to 0.5 percent from 1.4 percent in June.

The annual rate of growth in loans to non-financial corporations eased to 13.2 percent from 13.6 percent growth in June. That is still more than three times the growth rate the ECB might feel comfortable with, Cailloux said.

If inflation risks increase, the ECB may need to raise interest rates further, policy makers Lucas Papademos and Axel Weber said this week, even in the face of faltering economic growth.

A 66 percent increase in the price of oil over the past year has pushed euro-region inflation to 4 percent, eating into consumers' income and boosting companies' bills.

Wage Demands

IG Metall, Germany's largest trade union, whose wage accords affect 3.2 million workers, has said it will demand a bigger pay increase this year than last year's 6.5 percent claim. Wage negotiations between metal workers and employers in Europe's largest economy will commence next month.

ECB executive board member Juergen Stark told Sueddeutsche Zeitung earlier this week that he already sees ``broad-based second-round effects emerging.''

The euro-area economy contracted 0.2 percent in the second quarter from the first and is at risk of a ``genuine recession,'' as a stronger currency hurts exports, house prices fall and inflation erodes wages, Standard & Poors said yesterday.

Still, ``I don't expect inflation to come down necessarily just with weaker growth,'' ECB council member Weber said in an interview published yesterday. ``If the economic outlook brightens somewhat again toward the end of the year and next year, which I still expect, we'll have to see if action is necessary.''

Papademos told delegates at a conference in Buenos Aires that the emergence of a wage-price spiral would ``require a stronger degree of monetary tightening.'' He also said ``there is ``little evidence'' that a credit market crisis which has pushed up bank lending costs globally has ``significantly'' affected the euro area.

The comments prompted investors to reduce bets that a cooling economy will force the ECB to lower borrowing costs. The yield on the Eonia forward contract for May, which had fully priced in a 25 basis-point rate cut to 4 percent yesterday morning, was at 4.12 percent today.

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