Earlier today we received this announcement from the Governing Council of the European Central Bank.
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The interest rate on the main refinancing operations of the Eurosystem will be increased by 25 basis points to 1.25%, starting from the operation to be settled on 13 April 2011.
- The interest rate on the marginal lending facility will be increased by 25 basis points to 2.00%, with effect from 13 April 2011.
- The interest rate on the deposit facility will be increased by 25 basis points to 0.50%, with effect from 13 April 2011.
Those who follow this blog regularly will not have been surprised by this announcement as in my opinion it was well trailed by the ECB. If we go back to the Press Conference held by the ECB on the 3rd of March we saw this statement and the emphasis is mine.
It is essential that the recent rise in inflation does not give rise to broad-based inflationary pressures over the medium term. Strong vigilance is warranted with a view to containing upside risks to price stability.
Such doubts as there may have been were pretty much ended by the latest estimate for Euro zone inflation from Eurostat which showed an increase to 2.6%. This figure reminded everyone that the inflationary pressures the ECB had stated it was worried about are indeed present and maybe increasing. It also exceeded the ECB inflation target which is defined as follows: ”In the pursuit of price stability, the ECB aims at maintaining inflation rates below, but close to, 2% over the medium term”. So the excess is now looking like being at least 0.6% going forwards which is why the ECB has acted as it has.
An additional influence
The term of the current ECB President Mr.Trichet is coming to a close. He boasted a few months ago that over the lifespan of the ECB that the average inflation level in the Euro zone has been 1.97%. I believe that he wants to leave with that claim still valid, or at least as valid as it can be. If there was any doubt about this in my mind he has just erased it by mentioning the 1.97% inflation average today in answering a question at the Press Conference. So Mr.Trichet seems to be thinking of his epitaph and does not want it to be of a man who let the inflation genie out its bottle.
What do we learn from today’s introductory statement?
All in all, it is essential that the recent price developments do not give rise to broad-based inflationary pressures over the medium term. Our decision will contribute to keeping inflation expectations in the euro area firmly anchored…….the stance of monetary policy remains accommodative and thereby continues to lend considerable support to economic activity and job creation.
There is an element of trying to have your cake and eat it here.However there is also some truth in the statement that monetary policy is still very loose/expansionary.
Will this be a one-off or the beginning of a series of interest-rate rises?
In the Press Conference Mr.Trichet went out of his way to say that this move was not the beginning of a series of them. For those who do not follow these conferences the usual pattern is for Mr.Trichet to speak a lot but to answer very little to nothing!So any answer he does give is worth considering. However care is required in assuming that this statement is true as if we return to the introductory statement we get.
At the same time, interest rates across the entire maturity spectrum remain low
We are being reminded here that overall interest-rates in the Euro zone are historically low.Therefore if you have rising inflation the plain implication is that you will raise them towards more normal levels in an attempt to control the inflation. My conclusion here is that Mr.Trichet wants us to think that this is a one-off but he does not really mean it. From his point of view he may not face too many questions on the subject as his term ends this summer and he will be able to leave that job to his successor! Indeed just as I am typing this he was asked the question again and gave a contradictory reply which confirms me in my view.
We did not decide that this is one in a series of interest-rate rises….We will always do what is necessary.
If inflationary trends continue then let there be no doubt that the ECB will raise interest-rates again, as to how much and how many times one cannot be sure but we can be sure that unless something fundamental changes the ECB will act again.
This is many respects is a brave move by the ECB and many consequences will flow from it. Indeed some of them have already taken place. For example on my post on Portugal from earlier today I described how strong the Euro exchange rate has been. This has been reinforced by Mr.Trichet’s statement on the 3rd of March which I described above as investors anticipate higher interest-rates. So even before the decision it had led to a higher exchange rate.
In addition longer-term interest-rates have been rising ever since March 3rd too. Let me use Germany as an example of this. Her two-year government bond yield closed at on March 2nd at 1.56% and last night closed at 1.85%. So as you can see financial markets began to anticipate this move the moment they heard Mr.Trichet’s remarks on March 3rd. There are several implications from this of which the first is that if an interest-rate rise is expected than markets will act before the move takes place. The next is that by the amount of the increase which is 0.29% they are beginning to anticipate more than one move before we even had the first! On a more technical note this reinforces one of my criticisms of Adam Posen back in Septemebr last year when he did not allow for such moves…
So the move will have begun to have had an impact before it took place. Now it has been announced it will help to reduce the second-order effects of inflation in Europe. As to the first order effects of rising fuel and commodity prices it will sadly do little. But with one problem it is the right thing.
What is the problem?
We are back to the fundamental problem of the Euro zone which is that it does not have political union and a common fiscal policy. Therefore it has no way of dealing with the effect on the weaker Euro zone economies. We are back to the subject of what I call “three-speed Europe” and as interest-rates are being set for the fastest the slowest will be hurt by this.
Of the countries in trouble or likely to hit trouble most have housing markets which have a lot of variable interest-rates with the highest proportion being in Portugal where I understand that 99% of mortgages are at variable-rates. Tracker rates will rise today and other variable rates soon. Two of the countries that seem most likely to hit trouble next Spain and Italy both have a high proportion of variable-rate mortgages too.
So overall this move is around two-thirds right and one-third wrong.Welcome to the problem of setting monetary policy in the Euro zone! The magazine Private Eye over-egged the pudding in its latest episode when it said that the Euro zone was comprised of skint countries and Germany. But behind a good cartoon there is usually an element of truth.
Is Euro zone monetary policy being set to suit Germany again?
A Conundrum for you
The European Central Bank faces inflation of 2.6% and responds by raising its interest-rate from 1% to 1.25%. The Bank of England faces inflation of 4.4% on the same measure but leaves its official interest-rate alone at 0.5%….Furthermore many of its members tell us that raising interest-rates will not help reduce inflation.