Our MPC-ometer model predicts UK interest rate decisions based on a small number of economic and financial indicators. The model correctly explains 113 of 125 interest rate outcomes since the inception of the current policy regime in 1997 – a 90% success rate.

Earlier this year I applied the same analysis to ECB rate decisions and found a similar degree of predictability. The ECB-ometer includes 10 variables summarising trends in activity, inflation and financial market conditions. Eight of these variables also appear in the MPC-ometer, providing strong evidence of a common policy approach.

The chart below shows changes in the ECB’s main policy rate – the minimum bid repo rate – together with the ECB-ometer’s forecasts. Official rate changes are signalled by forecasts of +0.125% or higher and -0.125% or lower. The model correctly predicted seven of the eight increases over the last two years, with no false signals.

The ECB was widely expected to raise rates again in September, based partly on President Trichet’s use of the phrase “strong vigilance” at the August press conference. The model signalled an increased risk of tightening but the forecast of +0.12% fell just short of the trigger level. In the event, rates were left unchanged in September and “strong vigilance” was replaced by a commitment to “monitor very closely all developments” in the subsequent press statement.

The ECB-ometer’s forecasts fell back in October and November and the December reading is likely to be marginally negative, based on available data (estimate included in chart). The decline reflects weaker economic activity and tighter financial conditions, which have offset unfavourable inflation developments.

The ECB has continued to signal a tightening bias by emphasising upside risks to price stability in its monthly statements and speeches by key officials. However, the ECB-ometer suggests a neutral policy stance is now warranted by incoming data – see also here and here. The ECB is likely to retain a reference to upside inflation risks in the statement issued after next week’s meeting but this could be counterbalanced by acknowledgement that growth prospects have deteriorated, partly because of the strength of the euro. Such an adjustment would indicate a more symmetric policy outlook and could be the first step towards a rate cut in early 2008.