Stuck Between Rising Inflation and Strong Euro, European Central Bank Looks for Middle Ground.
European Central Bank head Jean-Claude Trichet is stuck in the middle, watching inflation rise and the euro soar, and hearing louder calls for a halt to -- if not a full-out reversal of -- the bank's gradual campaign of interest rate increases.
Though analysts are all but certain the bank will leave its benchmark rate unchanged at 4 percent on Thursday, fears of a weakening U.S. economy could force the ECB into action sooner rather than later.
All but one of 50 financial institutions polled by Dow Jones Newswires expected the bank to hold steady as it considers rising inflation in the euro zone -- a situation it is specifically charged with controlling -- and the effect that a euro above $1.45 could have on exports.
For the European Central Bank and the Bank of England, both meeting this week, their decisions come at a time of mixed signals from both sides of the Atlantic.
There are very real worries about the lingering effects of the U.S. subprime credit crisis, which has caused billions of dollars in write-downs at some of the world's biggest banks, roiling global stock markets and leaving the U.S. economy lurching. Revelations by Merrill Lynch & Co. and Citigroup Inc. about bigger-than-expected subprime losses have done nothing to restore confidence in markets, said Marco Annunziata, chief economist of UniCredit Markets & Investment Banking in London.
"The market thought it was getting reliable information -- the most scarce and precious commodity in this market turmoil -- and reacted accordingly," he said. "It was an illusion, and it has now been shattered, causing the market to fear that we might be back to square one, with a Fed that has already spent some ammunition and seems reluctant to fire more."
The U.S. Federal Reserve has cut its benchmark rate twice since last month in reaction to the credit crisis, bringing it to 4.5 percent. Trichet and the ECB, though, have long maintained that they act only when the euro zone's interests are in danger.
One such interest is inflation. Consumer prices in the euro zone surged 2.6 percent last month, the biggest increase since September 2005. That puts the ECB on track to miss its inflation goal for the eighth year in a row -- clearly vexing the bank, which has a target of below 2 percent.
Davide Stroppa, an economist with HVB in Milan, Italy, also pointed to recent signs of strength in the euro zone economy, a 13-nation bloc of more than 317 million people that accounts for more than 15 percent of global gross domestic product. Unemployment has fallen below 3.5 million in Germany for the first time in 12 years and is lower across the rest of the euro zone, he noted. "The unemployment rate now stands at 7.3 percent, confirming that the labor market remains robust and should support consumption over next quarters," Stroppa said.
Joerg Kraemer, chief economist at Commerzbank, said inflation worries may not be enough to persuade the ECB to raise rates when the Fed is cutting. "A good example of this is spring 2001, when inflation rose to 2.7 percent ahead of the May ECB council meeting," he said. "Even so, the ECB not only held back from a rate hike in May 2001; it made a cut."
Back then, however, the shadow of a financial meltdown being was not being cast in boardrooms, bank offices and trading floors. Worries about the U.S. economy and the prospect of more interest rate cuts there have sent the dollar to record lows against the euro and levels against the pound not seen in more than a quarter of century.
The euro's new highs Tuesday came as a result of traders buying and selling in anticipation of the ECB's decision, said CMC Markets analyst James Hughes -- a change from last week, when analysts were looking for the euro to go below $1.41.
That level leaves some politicians clamoring for a rate hike, worried about an economic pinch on companies that draw revenue in dollars but pay their costs in euros, or retailers who see their customers planning shopping trips to the U.S. to take advantage of the weak dollar.
"The ECB's hands are tied, but expect the rhetoric to emphasize the inflation risks -- after the latest CPI print, the hawks must be yearning for the next opportunity to resume the hiking cycle," Annunziata said.
With the pound at about $2.09, the Bank of England finds itself in a similar circumstance. But in Britain, the bank's interest rate increases appear to be putting the brakes on inflation, which peaked at 3.1 percent in March and eased back to 1.8 percent in September.
"The Bank of England could take the view on Thursday that a pre-emptive interest rate cut is justified to counter a growing risk that growth could slow sharply over the coming months in the face of significant headwinds," said Global Insight economist Howard Archer. "However, an early interest rate cut risks fueling inflation if growth proves to be resilient over the coming months, and we lean towards the view that the Bank of England will remain in 'wait and see' mode," he said.
European Central Bank head Jean-Claude Trichet is stuck in the middle, watching inflation rise and the euro soar, and hearing louder calls for a halt to -- if not a full-out reversal of -- the bank's gradual campaign of interest rate increases.
Though analysts are all but certain the bank will leave its benchmark rate unchanged at 4 percent on Thursday, fears of a weakening U.S. economy could force the ECB into action sooner rather than later.
All but one of 50 financial institutions polled by Dow Jones Newswires expected the bank to hold steady as it considers rising inflation in the euro zone -- a situation it is specifically charged with controlling -- and the effect that a euro above $1.45 could have on exports.
For the European Central Bank and the Bank of England, both meeting this week, their decisions come at a time of mixed signals from both sides of the Atlantic.
There are very real worries about the lingering effects of the U.S. subprime credit crisis, which has caused billions of dollars in write-downs at some of the world's biggest banks, roiling global stock markets and leaving the U.S. economy lurching. Revelations by Merrill Lynch & Co. and Citigroup Inc. about bigger-than-expected subprime losses have done nothing to restore confidence in markets, said Marco Annunziata, chief economist of UniCredit Markets & Investment Banking in London.
"The market thought it was getting reliable information -- the most scarce and precious commodity in this market turmoil -- and reacted accordingly," he said. "It was an illusion, and it has now been shattered, causing the market to fear that we might be back to square one, with a Fed that has already spent some ammunition and seems reluctant to fire more."
The U.S. Federal Reserve has cut its benchmark rate twice since last month in reaction to the credit crisis, bringing it to 4.5 percent. Trichet and the ECB, though, have long maintained that they act only when the euro zone's interests are in danger.
One such interest is inflation. Consumer prices in the euro zone surged 2.6 percent last month, the biggest increase since September 2005. That puts the ECB on track to miss its inflation goal for the eighth year in a row -- clearly vexing the bank, which has a target of below 2 percent.
Davide Stroppa, an economist with HVB in Milan, Italy, also pointed to recent signs of strength in the euro zone economy, a 13-nation bloc of more than 317 million people that accounts for more than 15 percent of global gross domestic product. Unemployment has fallen below 3.5 million in Germany for the first time in 12 years and is lower across the rest of the euro zone, he noted. "The unemployment rate now stands at 7.3 percent, confirming that the labor market remains robust and should support consumption over next quarters," Stroppa said.
Joerg Kraemer, chief economist at Commerzbank, said inflation worries may not be enough to persuade the ECB to raise rates when the Fed is cutting. "A good example of this is spring 2001, when inflation rose to 2.7 percent ahead of the May ECB council meeting," he said. "Even so, the ECB not only held back from a rate hike in May 2001; it made a cut."
Back then, however, the shadow of a financial meltdown being was not being cast in boardrooms, bank offices and trading floors. Worries about the U.S. economy and the prospect of more interest rate cuts there have sent the dollar to record lows against the euro and levels against the pound not seen in more than a quarter of century.
The euro's new highs Tuesday came as a result of traders buying and selling in anticipation of the ECB's decision, said CMC Markets analyst James Hughes -- a change from last week, when analysts were looking for the euro to go below $1.41.
That level leaves some politicians clamoring for a rate hike, worried about an economic pinch on companies that draw revenue in dollars but pay their costs in euros, or retailers who see their customers planning shopping trips to the U.S. to take advantage of the weak dollar.
"The ECB's hands are tied, but expect the rhetoric to emphasize the inflation risks -- after the latest CPI print, the hawks must be yearning for the next opportunity to resume the hiking cycle," Annunziata said.
With the pound at about $2.09, the Bank of England finds itself in a similar circumstance. But in Britain, the bank's interest rate increases appear to be putting the brakes on inflation, which peaked at 3.1 percent in March and eased back to 1.8 percent in September.
"The Bank of England could take the view on Thursday that a pre-emptive interest rate cut is justified to counter a growing risk that growth could slow sharply over the coming months in the face of significant headwinds," said Global Insight economist Howard Archer. "However, an early interest rate cut risks fueling inflation if growth proves to be resilient over the coming months, and we lean towards the view that the Bank of England will remain in 'wait and see' mode," he said.
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