ECB Invokes Strong Vigilance to Achieve Medium-Term Price Target and Anchor Expected Inflation

June 9, 2011

A statement from the ECB signals a likely increase of interest rates next month.  Sufficient justification for a second tightening by July was provided by the Bank staff’s revised price and growth projections, the evolution of which can be seen below.  Both estimates for year 2011 were revised higher, especially CPI inflation, which is now expected to exceed by over a half percentage point the target of below but close to 2.0%.

  GDP 2011 GDP 2012 CPI 2011 CPI 2012
06/11 +1.5/2.3% +0.6/2.8% +2.5/2.7% +1.1/2.3%
03/11 +1.3/2.1% +0.8/2.8% +2.0/2.6% +1.0/2.4%
12/10 +0.7/2.1% +0.6/2.8% +1.3/2.3% +0.7/2.3%
09/10 +0.5/2.3%   +1.2/2.2%  
06/10 +0.2/2.2%   +0.2/2.2%  
03/10 +0.5/2.5%   +0.9/2.1%  
12/09 +0.2/2.2%   +0.8/2.0%  


The statement uses the full spectrum of code words that previously have been employed one month before officials actually raised key interest rates.  After building a case for “upside price risks” based on “positive underlying momentum of economic activity,” higher energy and other commodity prices, ample monetary liquidity for accommodating price pressures, and recovering money growth, officials assert that “strong vigilance is warranted” and promise to to “act in a firm and timely manner” in order to avoid “broad-based inflationary pressures” and “secure a firm anchoring of inflation expectations.”  Two key assumptions behind the new CPI forecast are 1) that oil prices will decline somewhat and 2) that short-term interest rates rise in accordance with market expectations.  Current policy continues to be deemed “accommodative.”  The present refinancing rate of 1.25% is 300 basis points below its prior peak in 3Q08.

The ECB refinancing, deposit, and marginal lending rates were initially increased by 25 basis points in April to 0.5%, 1.25%, and 2.0%.  The favored size of rate increases appears to be 25 basis points, and that’s what markets have been assuming for July. 

The ECB did not revert to competitive bidding for its longer-term refinancing operations, retaining instead unlimited provisions on one-month and three-month tenders during the third quarter.  In this way, the separation principle between rate policy and other unconventional standards to promote market functionality was underscored. 

In the question and answer part of the news conference, Trichet indicated that the Governing Council had determined that Draghi has proper credentials for being the next ECB president.  On the euro’s value, he reiterated trust in the U.S. commitment to promoting a strong dollar but would not give an opinion on the appropriateness of its present level.  Many questions were directed at the apparent rift between the ECB and the EU/IMF on the issue of peripheral debt restructuring.  Trichet did not say anything different from previous positions. 

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

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