Divisions over how to combat the global economic crisis have morphed in a matter of months into a new disconnect between central banks in the United States and Europe on the threat posed by commodity-fueled inflation.
Rhetoric from Federal Reserve Chairman Ben Bernanke and European Central Bank President Jean-Claude Trichet this week underscored a deep transatlantic divide that has opened up at a time when surging oil, political pressures and mixed economic signals are adding to the challenge for monetary policymakers.
The message from Trichet after the ECB's monthly policy meeting on Thursday was crystal clear — the Frankfurt-based bank is worried about euro zone inflation, which at 2.4 percent has climbed to its highest level since October 2008, and is prepared to act, perhaps as early as next month.
"Strong vigilance is warranted with a view to containing upside risks to price stability," Trichet said, using a phrase that in the past has signaled a rate rise is imminent.
The Frenchman described a hike in April as "not certain" but "possible."
The Bank of England, which has held fire despite an inflation rate that is double its 2.0 percent target, is expected to tighten soon too, most likely in the second or third quarter of this year.
Before today, few would have predicted the ECB would move first.
But in Washington, where Bernanke delivered his semi-annual report to Congress earlier this week, the chances of a rate hike in 2011 look slim, despite the surge in oil above $100 per barrel and clear signs the U.S. recovery is gathering speed.
Bernanke told the Senate Banking Committee on Tuesday that he expected oil prices to have only a modest, temporary impact on U.S. inflation "at most" and said the Fed remained preoccupied with weak job creation.
The contrast is as stark as it was last year when the Fed embarked on a second round of "quantitative easing," dubbed QE2, despite denunciations of the money-printing policy in Europe and Asia.
"We seem headed for a historically unusual event where the ECB and the BOE will raise rates ahead of the Fed," said Nick Matthews, an economist at RBS in London.
There are sound economic reasons why that may happen for the first time since the ECB was created 12 years ago.
Headline inflation in the euro zone and in Britain was above central bank targets even before the latest oil price jump and many economists believe it will rise further in the months ahead.
In contrast, U.S. inflation remains relatively subdued for now.
The ECB and BOE have a mandate to focus on inflation alone, while the Fed is required by law to consider growth as well — a point underlined by Bernanke's focus on the labor market.
The U.S. economy also appears to have plenty of slack, in contrast to the euro zone's big economy Germany, which has experienced skilled labor shortages.
"As QE2 is ongoing and inflation risks in the United States are still relatively subdued, it would be confusing if Bernanke shifted his focus to inflation, in line with Trichet and (BOE Governor) Mervyn King," said Mark Miller, senior global economist at Lloyds Bank Global Markets.
But swift rate hikes in Europe and a prolonged period of transatlantic rate divergence clearly carries risks for the Fed as it could push down the value of the dollar further, stoking fears about the longer term U.S. inflation threat.
The dollar slumped to a near four-month low against the euro on Thursday after Trichet's hawkish news conference and has fallen to its weakest level against the British pound in over a year.
"The Fed has a communications management issue — they have to pivot from a focus on deflationary risks to flagging inflation as a risk and this can't be done rapidly," said Gilles Moec, an economist at Deutsche Bank.
Moreover, according to analysis by Fathom Consulting, oil persistently around $120 — only a little above where it is now — would add about 0.5 percentage points to UK and European inflation but more than 1.5 points to U.S. inflation because of greater American consumption of oil and its lower energy taxes.
Rapid hikes by the ECB and BOE are also fraught with dangers although Trichet played down ideas of a series of rises.
Britain suffered a shock contraction in gross domestic product (GDP) in the fourth quarter of last year and is girding for some of the deepest spending cuts in the developed world.
A poorly timed tightening there could undercut a recovery prematurely, exacerbating the country's housing woes and private debt problems.
For the ECB the stakes look even bigger.
It must be wary that a "one-size fits all" rate hike aimed at strong core economies like Germany does not expose countries like Portugal and Spain to new market assaults and threaten the consolidation programs in bailout victims Greece and Ireland.
"In our view, the ECB is preparing to raise rates too early," said Julian Callow of Barclays. "It should give the euro area economy more chance to get on a sustainable footing, particularly since it is still too early to tell how the intense fiscal consolidation in many countries will affect demand this year and next."
Asked on Thursday about the risks of a policy split with the Fed, Trichet said: "We have our own responsibility; the Fed has its responsibility."
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