Euroland Data Point to ECB Rate Hike a Week from Tomorrow

March 30, 2011

The last rate hike at the European Central Bank was by 25 basis points in July 2008 and shrouded in controversy, coming just over two months before the collapse of Lehman Brothers triggered an intensifying global recession.  The refinancing rate has been at 1.0% since May 2009, some 325 basis points lower than the prior peak.  Odds heavily favor an increase to 1.25% on April 7th, and the decision will again attract controversy because the joint floats troubled peripheral members like Greece, Ireland, Spain, Portugal and even Italy do not seems capable of handling a less accommodative credit policy.

But ECB President Trichet has repeatedly said that policy is guided by the trends found in the overall euro area economy, not its weakest or strongest parts.  On that basis, the case for raising the refinancing rate is very strong.

Consumer price inflation of 2.4% in the year to February was a half percentage point above the target ceiling, and its likely to stay above 2.0% most of this year.  The energy component accelerated from 3.3% in February 2010 to 13.1% a year later, while food inflation rose to 2.3% from zero.  Monetary officials at the ECB, unlike their Fed counterparts, do not favor core inflation over total inflation when setting policy, but even that advanced from 0.7% in the year to February 2010 to 1.1% in the subsequent statement year.  Labor cost pressures remain subdued, rising 1.6% in the year to 4Q10, but producer price inflation was at an unseemly 6.1% last month.

Real GDP expanded 2.0% between the final quarters of 2009 and 2010, and several first-quarter indications point to a doubling of the quarterly growth pace in the first couple of months of 2011.  The composite purchasing managers index posted an average score of 57.6 in the first quarter versus 54.9 in 4Q10.  Manufacturing averaged 58.0 after 55.7 in October-December, while services went up 2.2 points to 56.5.  The average retail PMI was 53.1 in the current quarter, 2.1 points better than in 4Q.  PMI scores above 50 connote positive activity, and readings greater than 55 signify a truly brisk pace.  The two largest economies in the euro area, Germany and France, had quarterly composite PMI readings of 60.6 and 59.6.  In other data, industrial orders in Euroland, which advanced 10% annualized in 4Q, were 2.7% higher in January than their fourth-quarter average level, and industrial output was 1.0% above the 4Q mean.  The region’s economic sentiment index averaged 107.3 this quarter, 1.7 points better than in 4Q10.

With GDP growing about 2.5% annualized this past quarter and consumer prices up by a similar amount over the past year, the authorities will have scant reservations against raising their main interest rate, which is at 1.0% nominally and very negative when adjusted for expected inflation over the coming year.  It helps also that February-over-February growth of 2.0% in M3 money, 2.6% in private loans, and 2.3% in private credit are all positive.  Between February 2009 and February 2010, in contrast, such had respectively been down 0.4%, down 0.3% and unchanged.  While money and credit growth remain subdued, their first and second derivatives of movement are each positive.  If the key interest rate had bottomed at 2% or 3% rather than a record low of 1%, officials might delay the start of tightening in the face of the sovereign debt problem and uncertain effects on growth of elevated oil prices and Japan’s natural disasters.  But with a 1% key interest rates, there’s only one decision that can be prudently made, and that is to raise that rate now.

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

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