ECB Policymakers Remain Sitting On The Fence

Thursday, February 02, 2006

Ignoring the recent surge in energy and other commodity prices the ECB policymakers chose today the way of remaining on the fence in the face of mounting global imbalances. The governing council decided unanimously to leave the leading overnight rate unchanged at 2.25% after the hike by a quarter percentage point in December.
While ECB president Jean-Claude Trichet stressed the point that Europe's interest rate setting body remains increasingly vigilant he injected further confusioning statements in the webcasted press conference (where issues like exploding money supply and the sudden slowdown in gold sales were left unquationed.) When asked by an Italian journalist whether he sees interest rates at an appropriate level he answered, "I did not say that," but never went as far as to say they were inappropriate. This leaves room for two kinds of speculation. Either the ECB has lost oversight of the monetary policy or we have to get used to the idea that central banks can be "a bit pregnant."
Trichet is certainly right on the spot though when he sees the outlook basically unchanged. The EU is still haunted by the two ghosts that go by the name of high unemployment and slow growth.
In his introductory statement Trichet pointed out that inflationary risks and downside risks to economic growth existed mainly on the external side.
The most important remarks made in the introductory statement:
"Downside risks to economic growth, relating, in particular, to persistently high and volatile oil prices and concerns about global imbalances, still dominate on the external side...
Risks to this outlook for price developments remain on the upside and include further rises in oil prices, a pass-through of oil prices into consumer prices stronger than currently envisaged, additional increases in administered prices and indirect taxes, and - more fundamentally - potential second-round effects on wage and price-setting behaviour. It is therefore crucial that the social partners continue to meet their responsibilities also in the context of a more favourable economic environment.
Turning to the monetary analysis, the annual growth rate of M3 remains robust, even though it moderated further in December. This moderation can be explained in part by an apparent resumption of the unwinding of past portfolio shifts, which exerts a dampening effect on headline M3 growth. However, the trend rate of monetary expansion remains strong, reflecting the stimulative impact of the prevailing low level of interest rates. In particular, growth in the most liquid components of M3 continues to be very robust and the annual growth rate of loans to the private sector has increased further. Mortgage borrowing is particularly buoyant, implying a need to monitor developments in the housing market closely. Overall, strong monetary and credit growth in a context of already ample liquidity in the euro area points to risks to price stability over the medium to longer term."
I take note that the ECB downplays M3 growth. Calling an overshooting of the 4% target rate by more than double "robust" is a nice euphemism that was unfortunately not challenged by any of the journalists present in Frankfurt.
"To sum up, the economic analysis suggests that indirect effects stemming from past oil price rises and already announced changes to administered prices and indirect taxes can be expected to have an upward impact on annual HICP inflation over the coming years. It also indicates that risks to price stability over the medium term remain on the upside. Cross-checking the outcome of our economic analysis with that of our monetary analysis supports the case for vigilance to ensure that the risks to price stability over the medium to longer term do not materialise."
The recent surge in commodity prices could start to play tricks on the ECB. Note that Trichet did not rule out that Euroarea inflation, which slowed to 2.2% in December, could be hit by this factor in the near future. I am a bit weary as the ECB always stresses the long-term inflation outlook but disregards the short-term outlook.
Taking it from my very own experience January inflation should see a spike upwards. This is because most prices of long-term contracts (insurance premiums etc.) get changed at the beginning of the new year in Europe and when I look at my heating bills, car insurance, entertainment costs and ski passes I come nowhere near to the official headline inflation rate of 2.2%. Double of it would be more appropriate.


Wikinvest Wire