THE day after Portugal threw in its hand and asked for rescue funding from the EU, the European Central Bank increased the pressure on the beleaguered economies of southern Europe and Ireland by raising interest rates. The quarter-point rise in the main policy rate, from 1% to 1.25%, had been so heavily advertised that a failure to follow through on the message of “strong vigilance” in March – code for an impending rate increase – would have been knocked the ECB’s credibility. But the timing was unfortunate, to say the least.

The rationale for the move is in any case far from convincing. Yes, inflation has risen to 2.6%, above the bank’s target of a bit below 2%. But as Jean-Claude Trichet, the ECB’s president, said today, the increase in inflation in early 2011 has largely reflected higher commodity prices. Unless these set off a wage-price spiral, they should have a temporary rather than enduring effect on inflation.

Is there any sign of such a response, the dreaded “second-round effects”? Hardly, while wages growth is still tame. Nor is there much reason to expect a surge in pay awards when the euro area has so much spare capacity following the wrenching recession of 2008-09. That’s also a reason not to over-react to the price pressures shown in business surveys since firms will find it difficult to push them through to customers when there is a lot of slack in the economy.

What about the story that money is telling? After all, the ECB takes pride in applying a “monetary crosscheck” to its economic analysis. Yet broad money is rising by just 2% and credit growth is feeble. The monetary message is surely to leave well alone.

Mr Trichet kept on stressing today that the rate rise had been taken to forestall second-round effects and to keep inflation expectations well anchored. But the argument can be turned on its head. If expectations are indeed firmly tethered, then the central bank does not have to rush to pull the monetary trigger at the first sight of commodity-induced rising inflation coming over the horizon.

It’s hard to avoid the impression that the crosscheck that really matters is not a monetary but a political one. The ECB’s governing council is cross with being pushed this way and that by governments during the sovereign-debt crisis. It is unhappy with the outcome of the March summit of euro zone leaders, which dashed its hopes that the main bail-out fund might take over its invidious and reluctantly assumed role of buying government bonds of the most debt-afflicted countries. Mr Trichet said today that the council was disappointed with the outcome of the European proposals, which “fall short of the necessary quantum leap in the surveillance of the euro area”. Today’s rate rise is aimed as much at shoring up the bank’s own credibility as at fending off inflationary spectres.

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1-4 of 4 fundamentalist wrote: Apr 7th 2011 5:16 GMT

It’s truly disgusting that the ECB would think about the future. Don’t they know that in the long run we’re all dead?

Recommend (5) Permalink Report abuse Wayne Bernard wrote: Apr 7th 2011 6:17 GMT

With both the ECB and China raising rates, the pressure to raise rates in the United States will increase. As shown here, with a hidden $100 trillion unfunded entitlement debt looming in the background, this is the last thing that America can afford:

http://viableopposition.blogspot.com/2011/04/hidden-american-100-trillio…

It is only a prolonged period of generational lows in interest rates that have postponed America’s insolvency.

Recommend (3) Permalink Report abuse bampbs wrote: Apr 7th 2011 11:12 GMT

Perhaps by making things worse with a rate hike, Trichet hopes to force the Eurozone to adopt “the necessary quantum leap in the surveillance of the euro area”.

Recommend (7) Permalink Report abuse Robert North wrote: Apr 8th 2011 12:42 GMT

Your explanation is as good as any’s…there certainly isnt any serious concern at fighting inflation, since consumer demand is so weak and deleveraging is still the main focus for borrowers.

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