As Fed Eases, Europe Signals Tightening

Sunday, 06 Mar 2011 02:50 PM

 

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European Central Bank officials signaled they are leaning toward raising interest rates next month to prevent surging commodity prices from generating broader inflation.

After President Jean-Claude Trichet last week shocked investors by calling an April rate increase “possible,” fellow policy makers indicated concern that rising food and fuel costs will push up other prices unless checked with an increase in the ECB’s key rate from 1 percent, a record low. Headline inflation, which includes volatile raw material costs, has been above the bank’s 2 percent limit since December.

“There are risks with having a number of months with an excessive inflation rate due to the cost of commodities and energy,” Bank of France Governor Christian Noyer told Bloomberg Television in Paris. ECB Executive Board member Lorenzo Bini Smaghi said failing to react to faster headline inflation would make monetary policy “more accommodative” and eventually spur other prices.

With economists concluding the ECB is all but certain to shift rates in April for the first since 2008, the euro rose to its highest in four months against the dollar today. The ECB’s inflation alarm sounds more urgent than that of the U.S. Federal Reserve, whose policy makers are signaling they are in no rush to lift their key rate from near zero with underlying inflation still muted.

‘Striking’ Contrast

The U.S. central bank, which prefers to monitor core inflation and is also mandated to help tackle unemployment, won’t raise its benchmark rate until the first quarter of 2012, according to a Bloomberg News survey of economists. Chairman Ben S. Bernanke said this week he sees little inflation risk.

“The contrast between the way the ECB and the Fed are viewing the world is striking,” said David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York.

Central bankers who eye core inflation do so because food and energy tend to react to weather and geopolitical tensions, which are temporary and immune to monetary policy. By monitoring headline prices, the ECB is watching for repercussions such as workers and companies seeking compensation for the higher costs.

With the price of oil rising above $100 a barrel and food prices climbing to a record last month, data this week showed euro-area inflation quickened to 2.4 percent in February from 2.3 percent in January. That’s the fastest since October 2008. Excluding commodity costs, inflation was just 1.1 percent in January.

‘Question Marks’

“Some question marks start to arise that some pressure for second-round effects develops, that some pass-through is being seen,” Noyer said in the interview. “We need to reaffirm very strongly that we will never let that happen.”

ECB Executive Board member Jose Manuel Gonzalez-Paramo said in Cape Town that a rate increase is “possible but not certain.” It is clear that “the risks to inflation are on the upside and it is the mission of the ECB to prevent those from materializing, so we are ready,” he said.

Cyprus central bank governor Athanasios Orphanides said in Paris that central bankers must be “pre-emptive” in fighting inflation and that nothing should “distract” them from delivering price stability.

Attending the same conference in Paris, Trichet avoided commenting on monetary policy, limiting his remarks to trade imbalances and warning “disorderly” currency fluctuations could harm economic growth and financial stability.

Series of Increases?

Economists at UniCredit Group, Morgan Stanley, Nomura International Plc and JPMorgan Chase are all now betting that the ECB will raise its benchmark rate to 1.75 percent by the end of the year. Those at ABN Amro Bank NV and Citigroup Inc. expect an increase to 1.5 percent.

Eric Chaney, chief economist at AXA Group, said the ECB will raise rates “a little” to restrain inflation expectations that can spur wage demands and to pressure governments to find a solution to the region’s sovereign debt turmoil. Weak credit growth will prevent a series of rate increases, he said.

The euro was headed for a third straight weekly increase against the dollar, the longest run of gains since October following Trichet’s comments. Julian Callow, chief European economist at Barclays Capital in London, said the risk of a continued advance means “it will be difficult for the ECB to raise rates too quickly if the Fed is still on hold.”

While Germany’s economy, Europe’s largest, is powering ahead, some economists said higher ECB rates will intensify the pain of the region’s so-called peripheral nations such as Greece and Ireland.

‘Macro Mistake’

The ECB last raised borrowing costs to combat inflation in July 2008, even though subsequent data revealed the economy was contracting. It was forced to reverse the shift three months later as the global financial crisis conflagrated.

“The last thing you need is for another big macro mistake pushing the euro area back into recession,” David Blanchflower, a former Bank of England policy maker, told Bloomberg Television’s “Inside Track” with Erik Schatzker.

Harvard Professor Kenneth Rogoff said in Paris that the ECB may feel compelled to act by the strength of Germany’s economy, which expanded at the fastest pace in two decades last year. The departure of Bundesbank President Axel Weber in April may also be persuading it to prove its inflation-fighting credibility, he said.

“The ECB is facing a very different set of conditions than the Fed,” said Rogoff, a former chief economist at the International Monetary Fund. “I can’t imagine a single rate hike will have a destructive effect on the economy.”

© Copyright 2014 Bloomberg News. All rights reserved.

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