ECB Monitoring Inflation More Closely

January 13, 2011

The ECB did not let above-target CPI inflation for the first time since November 2008 go unanswered. By unanimous vote, they inserted the following language into their press conference statement:

We see evidence of short-term upward pressure on overall inflation, mainly owing to energy prices, but this has not so far affected our assessment that price developments will remain in line with price stability over the policy-relevant horizon…. Very close monitoring is warranted.

The Governing Council

  • Admits that 2.2% CPI inflation in December was greater than officials expected.
  • Finds inflation expectations to be still “firmly anchored in line with our aim of keeping inflation rates below, but close to, 2%.
  • Kept a broadly balanced risk around the baseline inflation forecast that while such may stay above 2% in the near term, even increasing further temporarily but then “moderating again towards the end of this year.”  But they now concede that the balanced nature of inflation risk “could move to the upside.”
  • Reiterated repeatedly that policy is never pre-determined.  For now, the interest rate structure of a 1.0% refinancing rate flanked by a 0.25% deposit rate and a 1.75% marginal lending rate is considered “appropriate.”  So officials now believe that an imminent rate hike is unlikely, but they reserve the right to change their mind based on very close monitoring of inflation and expected inflation.
  • Low growth in broad money and bank lending are one reason for optimism that price stability will be preserved in the medium term.

The higher alert on inflation was the main message.  On growth, the view remains that a moderate recovery will continue.  Yes, dispersion exists between different economies, but that is true among states in the United States as well, which is a point Trichet had made before.  He added that he expects the dispersion of Euroland national growth rates to diminish in the future.

On unconventional policies, Trichet again stressed that they are separate from the basic stability-oriented monetary policy and merely serve to enhance the transmission mechanism of monetary policies.  Implicitly this means that the refinancing rate could be raised before the liquidity-enhancing programs like buying peripheral bonds have ended.

Trichet, as in December, drew a distinction between monetary union, which has been delivered, and economic union, which has fallen short of the framers original intent.  The ECB wants to see regional governments strengthen the stabilization fund, which provides aid to troubled countries, in both quantitative and qualitative terms.

The ECB press conference and statement have buoyed the euro and German long term interest rates.  EUR/USD, which was as low as $1.3088 overnight, advanced subsequently to as high as $1.3326, while 10-year bund yields, which had dipped two basis points to 3.03%, bounced back to 3.07%.  Only in early December, officials had shifted the risk assessment from slightly upwardly biased to balanced, and six weeks later a return to an upward bias is being entertained.  That’s clear evidence of treating each monthly policy meeting with no pre-conceptions.

Copyright Larry Greenberg 2011.  All rights reserved.  No secondary distribution without express permission.

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