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December 01, 2005


The ECB Plays Its Hand

As expected, the European Central Bank was unimpressed by advice to the contrary, and today increased its target policy rate by 25 basis points.  From BBC News:

The European Central Bank (ECB) has ignored warnings about an economic  slowdown and raised interest rates...

ECB president Jean-Claude Trichet countered these arguments by saying that recent data showed economic growth had strengthened in the eurozone during the second half of this year.

Even with the quarter percentage point increase, Mr Trichet said that interest rates were accommodative and consistent with anchoring inflation expectations.

The BBC article comes complete with this graphic (hat tip, the ever-watchful Shadya Yazback) that makes you want to say the man has a point:


_41078928_key_interest3_gra416

It is important to recognize, of course, that low interest rates are not necessarily synonymous with easy monetary policy, a point I have made in the past.  But, Jane Galt points out that "Mr Trichet faces the same problem that other central bankers confront:  how to fight inflation driven by high oil prices."  In other words, the ECB is to some degree just following the lead of its peer institutions -- whose policies have not exactly been disastrous.

In fact, the Skeptical Speculator documents that the rate hikes at both the Fed and the ECB are occurring in the context of what seem to be pretty solid growth prospects -- and one in which the worst fears about inflation appear to be passing.  That may suggest to some that the jump to make policy less accommodative tilts to overkill, but there is probably a good reason that the series of bad inflation statistics driven by the energy-price shocks of late summer are not translating into persistent inflation.  Let me suggest that the good reason has something to do with monetary policy.

With that in mind, the most important headline from today's move by the ECB may be this one, from EurActiv:

ECB raises interest rate, underlining its independence

December 1, 2005 in Europe , Interest Rates | Permalink

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Listed below are links to blogs that reference The ECB Plays Its Hand :

» Locking Swords from A Few Euros More
I'd simply love to be a fly on the wall in London this weekend. The G7 finance ministers are about to meet the central bankers, and as in by now well known, these two groups haven't exactly been hitting it... [Read More]

Tracked on Dec 2, 2005 5:44:21 AM

» Locking Swords from A Few Euros More
I'd simply love to be a fly on the wall in London this weekend. The G7 finance ministers are about to meet the central bankers, and as in by now well known, these two groups haven't exactly been hitting it... [Read More]

Tracked on Dec 2, 2005 6:08:50 AM

» The ECB finally raise rates - but should they have? from New Economist
After leaving interest rates unchanged for more than two years, the European Central Bank yesterday raised official interest rates by 25 basis points to 2.25%. The decision has sparked some interesting reactions. European share prices have rallied, the... [Read More]

Tracked on Dec 2, 2005 3:07:34 PM

Comments

Is it not true that the ultimate level of short rates needed in the US are largely determined by what other countries do? It seems that the FOMC has gone up "at a measured pace" to give time for others to adjust. New Zealand raise a quarter point today.

Gold is out of sync with the ten year treasury, but might be brought into line by rate increases around the world? I note that housing has slowed in Australia and I believe the latest new home figures in the US will be negated by a much lower figure next month. Is a slow down in housing and autos not enough to take out any remaining fear of inflation?

Posted by: Jack K. Miller | December 01, 2005 at 09:24 PM

"In other words, the ECB is to some degree just following the lead of its peer institutions -- whose policies have not exactly been disastrous."

Yep, but to make this argument work you need to assume that the underlying economic realities - the fundamentals - are the same. This I seriously doubt.

"ECB raises interest rate, underlining its independence"

Or you could say: by only a quarter point, underlying its lack of it.

My view is that the ECB is playing with fire here (as is the BoJ). If they have read the tealeaves badly (and I think they have) and if the German data fail to improve and the Italian data turn downhill again (which I think might well happen) then this may be the last time the ECB will dare to make a decision which isn't approved of by the finance ministers first.

So was this a balanced risk, to call the shots when only a quarter point is in play. I think not. If I was going to make a risky call, one which could threaten my long term independence methinks I would want to do it for something a bit more susbtantial.

But then wishy-washyism has been one of the defining characteristics of the ECB since the start.

Incidentally, I think the expression 'eurozone' is one which lacks meaningful content in the real world. You need to talk individual countries here, and talking countries this decision is just fine for France, and M. Trichet is, well, French: I don't doubt that this fact won't go unnoticed in Germany.

Posted by: Edward Hugh | December 02, 2005 at 02:28 AM

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