The Empire strikes back

There have been many recently who have questioned the interest rate policy of the ECB. Now Trichet fends off the critics, most notably the Eurozone's financeministers, who have arguing against the ECB's course.

First off, we consequently have the relationship between the finance ministers and the ECB which itself is questioned. So apart from the obvious economic problems with the Euro, there are governance issues as well; Trichet stands firm though.

[quotes below from the FT] 

'Mr Trichet has given the cold shoulder to calls for intensified co-operation with finance ministers, arguing there is already sufficient contact between himself, the European Commission and eurozone finance ministers.

Comments by Mr Trichet in Madrid last week suggested he would prefer to see a similar sort of relationship between politicians and the central bank as in the US or UK, where politicians have learnt that outspoken comments can have a damaging impact on financial markets.'

I actually tend to agree with Trichet here (especially when markets exhibit volatility as they do now) but the important point is still that the Eurozone is a different beast than the US and UK for that matter. Trichet would be unwise to shut himself off in an Ivory Tower because the diversity of the Eurozone members is exactly what is causing many of the ECB's issues; in other words - he needs those finance ministers at least until all Euromembers converge into a single economic entity which is not in the immediate horizon I would say.

Moving on to economics ... where the ECB's actions are '“carefully calibrated to the structural characteristics” of the eurozone.'

'But the ECB president argued that inflexible continental European economies increased the impact of small changes in borrowing costs, and that the ECB’s actions had been “carefully calibrated to the structural characteristics” of the eurozone.

“A central bank operating in a relatively rigid economy is able to deliver the same quantum of monetary accommodation by adjusting its policy instrument in more moderate steps than in a relatively more flexible economy,” Mr Trichet said at a conference organised by the Spanish central bank.'

And further raises are in the crystal ball.

'Since December last year, the ECB has started lifting eurozone borrowing costs from historic lows. Last Thursday it announced the third quarter percentage point rise since last December, taking its main interest rate to 2.75 per cent.

Mr Trichet has signalled that borrowing costs are likely to rise further later this year, saying in his Madrid speech that “we are in a process of progressively withdrawing the present degree of monetary accommodation”.'

This is the same narrative as all the two other major CBs (BOJ and the Fed), although the BOJ has not embarked on serious raising yet. All that liquidity needs to be scooped up to avoid inflation. In terms of the BOJ its decision to raise rates for real would certainly impact the markets, especially the emerging ones, as carry trade starts to unwind. But can the BOJ raise rates? The Economist are good here although they still tend to believe in a sustained Japanese recovery ...

'When financial markets are skittish, ending the zero interest-rate policy could knock confidence. The BoJ's room for manoeuvre has been suddenly constrained.'

In terms of the Eurozone though the Economist throddles around in utopia taking the best case scenario for granted. All I am saying here is that more caution and differentiation might be called for.

'New jobs, rising consumer confidence (which is at a five-year high) and, in some countries, surging house prices (see article) should encourage households to open their wallets. Indeed, euro-zone retail sales rose by a faster-than-expected 2.8% in the year to April. Even German consumer spending is picking up, helped by the World Cup.

(...) 

Stronger growth allows the ECB to focus more intently on its inflation target: namely, holding inflation close to, but below, 2%. The average inflation rate in the euro area rose to 2.5% in May, which was higher than expected, and the European Commission's latest survey showed that inflation expectations are edging up.'

Another view of the ECB's monetary policy comes from FT's Munchau; I only have the teaser so this is perhaps why I do not exactly understand his narrative; is he seeing something I am not?

'So much for the idea that European central bankers are inflation nutters. Not only did Jean-Claude Trichet, president of the European Central Bank, refrain from raising short-term interest rates by more than the expected quarter point last Thursday. His assessment of future inflation risks appeared so careful and nuanced that some market participants even characterised him as dovish.

Mr Trichet and his colleagues are not monetary policy doves. Their refusal to commit to future interest rate increases constitutes a shift in the ECB's stance – but only towards more flexibility, not towards a looser monetary policy. Europe's central bankers do not want to tie their hands at a time when the euro's exchange rate appreciates and when financial markets are volatile.'

All this obviously cannot be detached from what happens across the pond and in Asia. For that I recommend two Bloomberg columns ...

William Pesek Jr on Asian anticipation of Bernanke's move. 

'None of this means Asian policy makers can sit back this time and wait for Fed Chairman Ben Bernanke and European Central Bank President Jean-Claude Trichet to do their work for them. That was possible in the past, when Asian currencies were more closely pegged to the dollar and capital markets in the region were too small for local monetary-policy shifts to matter much.

Now, Asia may have little choice but to embark on its most aggressive monetary-tightening campaign in a decade. The good news is that the region has done much to strengthen economies since the late 1990s. Currency reserves have been amassed, banking systems are more stable, corruption is being addressed, albeit gradually, and living standards are edging higher.'

Would not many Asian economies also want to wait and play the mercantilist card here? The question obviously is whether this is possible for them? 

Kevin Hassett on Bernanke's troubles

'The headlines have hardly been the kind a new Fed chairman would desire. Last week, the Associated Press ran a story headlined ``Fed's Warning Roils Markets.'' CNN.com did a story on ``The Bernanke Panic.''

Reinforcing the view that Bernanke is confusing markets was a review of his public comments by TheStreet.com, which asserted that in a fairly short span, he has moved from inflation hawk to dove and back to hawk. Bloomberg News columnist Caroline Baum captured the mood on trading floors best with last week's piece titled, ``Traders Pine for Days of Greenspan Spoon Feeding.''

While all this chattering has been going on, equity markets have headed down, big time. Whenever investors lose money, they seek a scapegoat, and everyone seems to have found the perfect one in Bernanke.'