ECB Does Nothing, Indicates Monetary Tightening

Thursday, November 05, 2009

Leaving its key interest rate unchanged at 1% on Thursday, the European Central Bank (ECB) appears to remain in standby mode, keeping financial institutions flush with cheap liquidity. The only new twist in President Jean-Claude Trichet's repetitive flood of calming words came in the Q&A session as reported by the Wall Street Journal:
The European Central Bank will begin absorbing excess liquidity from its monetary stimulus programs in a "timely" fashion, ECB President Jean-Claude Trichet said Thursday.
"Not all liquidity measures will be needed to the same extent as in the past," Mr. Trichet told a news conference, without being more specific. "Enhanced credit support on which we embarked is not for eternity."
He added that: "We expect [past] policy action will progressively feed through to the economy."
The introductory statement offers no fresh insights save for the point that the ECB warned governments not to lower taxes before the overall picture has significantly improved. Well, we certainly need not fear lower taxes in the technically bankrupt Euro member countries.
From the statement:
...many euro area governments are faced with high and sharply rising fiscal imbalances. If not addressed by a clear and credible exit strategy, this could seriously risk undermining public confidence in the sustainability of public finances and the economic recovery.
The very large government borrowing requirements carry the risk of triggering rapid changes in market sentiment, leading to less favourable medium and long-term interest rates. This in turn would dampen private investment and thereby weaken the foundations for a return to sustained growth.
Moreover, high public deficits and debts may complicate the task of the single monetary policy to maintain price stability. The Governing Council therefore calls upon governments to communicate and implement in a timely fashion ambitious fiscal exit and consolidation strategies based on realistic growth assumptions, with a strong focus on expenditure reforms. Tax cuts should only be considered over the medium term, when countries have regained sufficient room for budgetary manoeuvre.
If there is one thing I do not fear, it is lower taxes.
The ECB may currently be in a worse position than the Federal Reserve. Although I doubt US growth figures the economic situation of most European countries is still in the process of declining to new lows.
Trichet will soon face a tricky question: How to rein monetary inflation while not killing any future green shoots with higher interest rates,
We are in a unique situation that is fundamentally different as both record recessions and interest rates are at historic lows. By doing nothing for an extended period the Eurozone members risk higher government interest rates once markets begin to question the sustainability of a recovery without jobs and without growth.
Indebted consumers are not able to assist in the recovery: Latest Eurostat figures show that retail sales (PDF) declined minus 0.7% in September MOM.


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