ECB: A Straight-Forward Written Statement but a Contentious and Confusing Press Conference

July 7, 2011

The ECB raise all three of its key interest rates by 25 basis points today.  This was its second tightening following up by three months on an initial move.  The rate corridor surrounding the new 1.5% refinancing rate remains 150 basis points in width with a 0.75% deposit rate and a 2.25% marginal lending rate.  The width at the peak of the prior tightening cycle was 200 basis points (3.25-5.25%).  The ECB’s statement in June had used coded language to signal an elevated probability, but not certainty, that rates would be lifted today, so the move had been expected.  No changes were announced in any of the non-standard measures, but the ECB reiterated that such, by design, are “temporary in nature.”

Today’s statement lists a number of familiar justifications for hiking interest rates and promises “to monitor very closely all developments with respect to upside risks to price stability.”  The qualifying adverb, very, has sometimes in the distant past been associated with a subsequent tightening two months later, but that wasn’t the case in April 2011.  The insertion of “very” into the language creates flexibility to move again in as little as two months, but the more likely interval will be three months or longer.  Policy has been tightened

  • Because CPI inflation remains well above the medium-term target of below, but close to, 2%, and “relatively high” inflation is expected to continue over coming months.
  • Because medium-term price risks remained skewed to the upside.
  • In order to continue anchoring medium-term price expectations in line with the ECB target.
  • Because policy remains accommodative.  Note that the statement does not also say that present policy is also appropriate.
  • Because growth, while slowing, is expected to remain positive in an environment characterized by upwardly skewed price risks and historically low interest rates across the entire maturity spectrum.

An implicit need for caution in tightening policy is conveyed in the statement’s text, suggesting rate increases are unlikely to exceed 25-bps in size and to be spaced out as the first and second were.  Caution is not based explicitly upon the peripheral debt crisis but rather on continuing elevated high levels of global and regional uncertainty associated with balanced growth risks around a baseline forecast of moderately positive expansion.  Today’s rate hike decision, like April’s, was made unanimously by the 22-person Governing Council.

Most questions in the press conference were devoted to the sovereign debt crisis.  Trichet kept using the word “clear” to describe the central bank’s opposition to credit events, defaults, or selective defaults.  However, the discussion was anything but clear in defining hypothetical scenarios in case one of those possibilities occurs.  Monetary authorities are demanding that all parties live up to their mandated responsibilities, and the ECB’s task is a narrow one, namely delivering price stability in line with its target.  Trichet seemed irritated at the bombardment of questions about Greece, Ireland, Spain or Portugal, which he believes should properly be directed to those respective governments and others.  In fact, not everything that ECB officials are saying and doing seem consistent with the spirit of “saying no to all defaults and selective defaults,” for the central bank released a second statement today that until further notice “suspends the application of the minimum credit rating threshold in the collateral eligibility requirements for the purposes of the Eurosystem’s credit operations in the case of marketable debt instruments issued or guaranteed by the Portuguese government.”  Similarly, Trichet would not be drawn into voicing an opinion on the role of the credit rating agencies in defining the creditworthiness of sovereign debt.

Trichet’s position in the debt crisis would be difficult at any time, if, for example, if he had been on the job just a few months or alternatively were midway through his eight-year term.  The fact is that he’s a lame duck.  He has one vote on a committee of 22 but speaks with exclusive authority about the view of the entire committee.  Power and authority inevitably ebb for all lame duck leaders, whether in the private or public sectors, as the finish line approaches.  Trichet will preside over only three more scheduled interest rate meetings with press conferences.  After that, he’ll be no more relevant for market players than his predecessor Wim Duisenberg or the sequential Bundesbank presidents, such as Emminger, Poehl, Schlesinger, and Tietmeyer, while Germany’s central bank effectively set monetary policy throughout Europe prior to 1999.  Trichet is not able single-handedly to resolve the debt crisis, a situation that challenges the euro whose stability and safety he is sworn to uphold.  Even if the Governing Council had such power, Trichet’s ability to exercise it with his successor, Mario Draghi, sitting on the same council should not be assumed automatically. 

Forex markets rightfully did not know how to react to the press conference, and so the euro did not move extensively.  The table below shows the euro’s value against the dollar, sterling, Swiss franc and yen near the start of the press conference (12:41 GMT), end of the press conference (13:39 GMT) and an hour after such had ended (14:35 GMT).

  12:41 GMT 13:39 GMT 14:35 GMT
$ per euro 1.4238 1.4291 1.4363
euro per GBP 0.8909 0.8942 0.8983
CHF per EUR 1.2081 1.2078 1.2136
JPY per EUR 115.83 116.18 116.73


A final insightful observation gleaned from today’s press conference came in response to a question about the mid-point of the ECB staff’s CPI inflation forecast of 1.1% – 2.3% in 2012.  The midpoint of 1.7% is consistent with the target, and the question wanted to know whether further tightening would be necessary if medium-term inflation is indeed expected to be okay.  Trichet replied that the forecast implies ongoing tightening and then noted that forecasts are only made in range terms, not associated with any midpoint, because of considerable uncertainty about the future.  Calculating the mid-point of a range forecast is a common analytical technique, which I do as well.  Trichet is reminding us that the probability distribution of possible results is not necessarily distributed evenly within the range, so those assuming the mid-point is the most likely outcome are assuming more information than officials intend to convey.  The forecast for inflation a year from the time the calculation is made presumably will always include territory that meets the target because it is the sworn duty of monetary policy makers to do whatever is possible to meet its mandate.  Viewed this way, the forecast provides no useful content. 

The other interesting revelation is that the forecast embodies ongoing monetary restraint, an admission that seemingly contradicts the oft-repeated assertion that future policy is never pre-committed.  From all this, I take away this truth:  monetary policymaking works through controlling expectations as much as customizing monetary growth to the evolution of money demand, and the process of shaping expectations involves acting in consistent and predictable ways but communicating such often within riddles.

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

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