PARIS (MNI) – With eurozone HICP at a record high and inflation
risks on the horizon as far as the eye can see, the European Central
Bank’s Governing Council is stiffening its resolve as the defender of
price stability, even at a time of great uncertainty about economic
growth, well-informed monetary sources have told Market News
The ECB is still piloting the monetary aircraft in a thick fog as
inflation rises well above the bank’s comfort level and ongoing market
turmoil, accompanied by a sharp slowdown or recession in the United
States, clouds the view, these sources said.
But the thinking in Eurosystem monetary circles appears to have
shifted recently, as oil continues its steady rise and workers in
Germany win bigger-than-usual pay increases.
In recent months, as unabated turbulence roiled markets and the
U.S. economy slipped towards the abyss, many eurozone monetary
policy-makers saw price risks as an obstacle to cutting rates. Now, the
ascending view is that a lack of clarity over how sharply growth will
slow is what’s keeping the ECB from putting up rates.
“Nobody talks about an interest rate cut anymore,” said one source.
“It’s a wait-and-see policy, as it has been for awhile, but the bias has
That is not to say the ECB has formally returned to a tightening
bias. But there is an awareness that unless inflation behaves, the next
move could very conceivably be a rate hike — in contrast to market
expectations, albeit receding ones, for a cut.
“With inflation running at 3.6%, the ECB could be forced to tighten
monetary policy,” said one senior Eurosystem official. “This will depend
on whether inflationary pressures from oil and food price hikes create a
second round of increases in wages and consumer products.”
Another official put it more bluntly: “The fact is that if the
money markets can be stabilized, then rate hikes would have to be put
back on the agenda,” he said.
But such a move, if it comes at all, may still be a long way off.
The official who observed that “the bias has moved” also said,
“It’s difficult to see rates going up at the moment, with the financial
sector still weak and the U.S. maybe in recession. Higher rates here
will make it worse for financial institutions. They are still
He also noted that “there is already some tightening effect in the
markets,” given the strong euro and the rise in three- and six-month
rates, which are now well above 4.8% — more than 80 basis points north
of the ECB’s main policy rate.
The senior Eurosystem source made it clear that while perceptions
may have hardened with regard to inflation, no imminent action by the
ECB is likely because the economic picture is just too cloudy for now.
“The markets should not expect monetary policy changes during the
coming months, despite market and political pressures,” he said. “We are
in no position to make a medium-term assessment, since we are not fully
aware of the banking sector’s exposure to the financial market crisis.”
Therefore, policy is still finely balanced for now between two
conflicting pressures, he said. “The one is an interest rate increase
and the other is a rate cut. As a result, the Council has decided to
freeze any action and continue to inject the market with liquidity.”
Nonetheless, the more hawkish comments by MNI’s sources —
including that senior official — jibe with recent public remarks by
some members of the ECB Governing Council, who have resurrected the idea
of hiking rates in the face of what they see as an extremely worrisome
In a newspaper interview published today, Luxembourg Central Bank
Governor Yves Mersch said the ECB staff would probably revise upward its
inflation forecasts for 2008 and 2009. Asked if this implied the ECB
would have to hike interest rates, he said the question was “entirely
Bundesbank President Axel Weber, expressing great alarm about
inflation developments, said Monday that the ECB must “decide whether
the current level of interest rates ensures the fulfillment of our
mission.” And Bank of Greece Governor Nicholas Garganas pointedly noted
on Friday that he had not ruled out a rate hike.
The only way the ECB can reconcile higher interest rates *and* pacify the hyperleveraged, debt-glutted Club Med, would be by swapping quality debt, Bernanke-style, for the banks’ asset-backed garbage, and subsidizing the Club Med/ Ireland banking sector commensurate with the size of those countries’ gargantuan trade deficits.
Italy will be the one to watch. We will soon see whether the fulcrum of Berlusconi’s coalition, Umberto Bossi’s anti-euro Lega Nord, can be bought off or not.
But at least the ECB is trying.
On another note, Bernanke is said to be heavily influenced by the work of Athanasios Orphanides, the chairman of the Bank of Cyprus, whose philosophy can be summarized as, “When there’s a recession, cut interest rates until interest-rate expectations begin to become unmoored.” By every indicator, including the laggardly consumer surveys, inflation expectations have become significantly unmoored. If there is any time for Bernanke to stun Wall St. and the commodities markets with a 25 basis-point rate hike, it would be on April 29-30. (Not that I think Bernanke will.)