Will Monetarism Prevail at The ECB?

We will certainly see won't we? In terms of data the story is pretty much unchanged; inflation continues its slight but steady downward course primarily driven by a dropping headline. Notice also (just for fun) how the the infantry is rallying behind Trichet at the ECB :).

(From Bloomberg - bold parts are my emphasis)  

Inflation in the dozen euro nations slowed in October as the first annual drop in energy prices since 2004 kept the rate below the European Central Bank's limit for a second month.

Consumer prices rose 1.6 percent from a year earlier, below the 1.7 percent gain in September and the lowest since February 2004, Eurostat, the European Union's statistics office in Luxembourg, said today. Energy prices fell 0.5 percent in October from a year earlier, the first decline in 31 months.

The slowdown in inflation isn't easing concern at the ECB that price increases will accelerate next year. With inflation expected to breach the central bank's 2 percent ceiling for an eighth year in 2007, ECB council members this week have signaled they may support further increases in interest rates next year.

``Today's number does not alter the current ECB hawkish stance,'' said Aurelio Maccario, an economist at Unicredit Banca Mobiliare SpA in Milan. ``From the current trough, inflation is set to rise in the months to come and will stay above 2 percent in the first months of 2007.''

(...)

ECB council member Nout Wellink said Nov. 13 interest rates in the 12 nations sharing the euro are still ``damn low.'' His Greek colleague Nicholas Garganas said a day later that policy makers will show ``strong vigilance'' on inflation.

The central bank, which expects inflation to average 2.4 percent this year and next, may also be concerned that a German government plan to raise the value-added tax to 19 percent from 16 percent in January will lift the inflation rate, said Martin van Vliet, an economist at ING Financial Markets in Amsterdam.

``The ECB still sees upside risks to future inflation,'' Van Vliet said, citing strong credit growth, possible wage demands and the increase in the German sales tax.

My main gripe here is not whether monetarism beats inflation targeting or not, that is a discussion for another day. I mean whoever said that 'money' was not a salient indicator anyway? However, I seriously have the feeling that the ECB is playing into hands of something which they do not understand here. Inflation is dropping on account of falling energy prices which is a direct effect of the US' and indeed the Eurozone's own slowdown moving into 2007. The monetarist indicators still show above target liquidity but think here about Germany and Italy and their efforts to reign in their budgets for 2007 and indeed going forward. The bets are still out on this question but if the sh't hits the fan in the first quarter of 2007 for real; deflation is a serious threat to Germany and Italy I think.