A Big Say From Central Bankers But Not the Final Say

August 28, 2008

Currency movement is driven not merely by shifts in relative growth, but as the preceding post suggests, by the reaction of monetary policymakers to that growth.  Weakening growth in Europe has not been met by an ECB cave-in.  There was only one rate change in Euroland since the global credit crunch began, and that move was in fact a rate hike this past July.  The rhetoric of ECB officials this week has continued to accentuate the primacy of containing accelerating inflation.  Investors wonder, however, if that talk is just posturing. Blogger Jamie McGeever bluntly asks today if this is just a bunch of ECB hot air?  Any further rise of ECB rates in present circumstances seems almost inconceivable, and a case for a rate reversal hangs over market psychology.   In the cat-and-mouse game between the market and central bank, I submit that the interplay goes on at a deeper level than the matter of sizing up if the policy-maker’s word can be trusted.  What really counts is the policymaker’s judgement to do the right thing.  Correct policy is situational and an especially difficult call when, as now, facing both rising inflation and weakening growth.  Not always, but most of the time, currency markets end up rewarding the monetary policy that seems most appropriate for the circumstances.

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