World Economy: The President of the European Central Bank (ECB), Jean-Claude Trichet, has created a huge surprise,

Jun 6, 2008

The President of the European Central Bank (ECB), Jean-Claude Trichet, has created a huge surprise,

The President of the European Central Bank (ECB), Jean-Claude Trichet, has created a huge surprise, Thursday, June 5, in the early afternoon, saying that the central bank might raise rates at its next meeting in July, in order to contain inflationary pressures. A few hours earlier, the Governing Council of the ECB was left unchanged at 4%, its refinancing rate.

"It is not excluded that we decide to move on our rates at the next meeting to ensure the solid anchoring of inflation expectations," said Dr. Trichet. A "light" rate hike is "possible" but "not certain," he said.

Nobody expected that the ECB and hardens tone and announced an imminent tightening of monetary policy. A few weeks ago, several of its leaders had discussed the possibility of a rate hike, but his remarks were seen as mere verbal provocations. Economists, however, foresaw the maintenance of the status quo observed since the beginning of the crisis subprimes in the summer of 2007. They were anticipating even at the end of the year, a rate cut to accommodate the expected slowdown of growth.

To justify in advance what unexpected turn screws, M. Trichet insisted the new surge in inflation, which erodes the purchasing power of citizens. Consumer prices rose by 3.6% over one year in the euro area, a record level. However, according to the chairman of the ECB, these tensions are likely to persist. Inflation is expected to "remain above 3% for some time, before declining only gradually, in 2009," said Trichet. The National Bank, which has set a target of 2%, now provides a level of 3.4% in 2008 and 2.4% in 2009. But in March, he still anticipated rates of respectively 2.9% and 2.1%.

Mr. Trichet explained that "acting in a timely and firm manner, we can avoid second-round effects", ie a contagion of soaring consumer prices to wages. "These second-round effects are the enemy," he hammered. He added that it was in this respect not replicate the mistakes made in previous oil shocks.

However, the president of the ECB has shown little optimistic about growth prospects in the euro area. He wished to relativize the excellent performance of the first quarter (+ 0.8%), referring to "temporary factors" as mild winter which has supported the construction sector and public works. And for 2009, the National Bank no longer provides a higher gross domestic product by 1.5%, against 1.8% previously.

STRATEGIC SHIFT TO THE FED

Raising programmed rate of the ECB despite the economic slowdown expected confirms the shift monetary strategy on both sides of the Atlantic. While the ECB favours for several months the fight against inflation, the U.S. Federal Reserve (Fed) has chosen a priority to combat the risk of recession by lowering interest rates sharply, down 5.25% to 2% in nine months.

Beyond the strength of European banks to the crisis subprimes, the divergence of strategy is explained by historical and cultural reasons. The Fed is still marked by the trauma of mass unemployment during the Great Depression, the ECB - heir to the Bundesbank - that of the hyperinflation of the years 1920.

The statements by Mr. Trichet has caused turmoil on the foreign exchange market. Earlier this week, the Fed chairman, Ben Bernanke, had already sown the trouble expressing concern for the first time, the impact of a weaker greenback on inflation in the USA. His comments had led the dollar to recover.

But the prospect of rising interest rates in the euro zone, which would make it more profitable European currency, made reperdre to the greenback gained ground. The euro has surged, Thursday afternoon, 1.5360 to 1.5560 dollar. Indeed, a strong euro - which reduces the prices of imported goods, notably oil - is an ally for the ECB in its fight against inflation.

If it leaves monetary presage a battle between Europe and the USA - both seeking a strong currency - the higher rates ahead of the ECB might also move seriously relations between Frankfurt and governments in the euro area . They have praised the work of Mr. Trichet to manage the crisis subprimes. But this surprise monetary tightening, penalizing short-term growth and employment, looks for them very difficult to digest.

World Economy

The President of the European Central Bank (ECB), Jean-Claude Trichet, has created a huge surprise,

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