ECB and damage control policy

As much as you might not like their decisions it is almost impossible not to feel sorry for ECB. From the get go the ECB had to live up to the legacy of the Bundesbank. Thus in order to gain the trust of the markets the ECB was given a mandate of keeping inflation below but close to 2% over the medium term making it implicitly an inflation targeting central bank. The other “asset” supporting its credibility was the building of its headquarters in Frankfurt. This way there is no confusion to which type of monetary policy regime ECB would adhere.

Yesterday’s release of the press statement after the interest rate decision and the Q&A session afterwards showed a tired central bank that is hiding behind its mandate of fighting inflation. To me there were  few momomnets and statements that show a worried central bank. The ECB rightly points to a slowdown in the EU economy and obviously a fall in prices over the medium term. In this environment it is normal that ECB would not increase rates further. But did the last two increases this year harm the fragile growth in the euro zone? Did it make it harder for troubled EU countries to borrow in the short term? For the latter point ECB asks those countries to get their fiscal story in order but adjusting a fiscal deficit will take years and by making costs of borrowing higher does not help those countries either today or in the future.  Future economic research might show that those two increases might have cost Europe dearly. For now ECB hides behind the inflation targeting mandate to justify for the rate increases this year. But for a central bank which is supposed to look at medium term the change in view in a span of two months does not make sense.

The Q&A session is a must this time. Very good questions and some good answers.  There is one point were Mr. Trichet gets angry as the recent job done by ECB especially within the context of global crisis.

Here are the main paragraphs from the statement:

“…real GDP growth is expected to increase very moderately in the second half of this year. At the same time, we continue to expect euro area economic activity to benefit from ongoing growth in the global economy as well as from the accommodative monetary policy stance and the various measures taken to support the functioning of the financial sector. This assessment is also reflected in the September 2011 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP growth in a range between 1.4% and 1.8% in 2011 and between 0.4% and 2.2% in 2012. Compared with the June 2011 Eurosystem staff macroeconomic projections, the ranges for real GDP growth in 2011 and 2012 have been revised downwards.

In the Governing Council’s assessment, the risks to the economic outlook for the euro area are on the downside, in an environment of particularly high uncertainty. Downside risks mainly relate to the ongoing tensions in some segments of the financial markets in the euro area and at the global level, as well as to the potential for these pressures to spill over into the euro area real economy.”

“With regard to price developments, euro area annual HICP inflation was 2.5% in August 2011, according to Eurostat’s flash estimate, unchanged from July. We have now seen inflation rates at relatively high levels since the end of last year, with higher energy and other commodity prices as the main drivers. Looking ahead, inflation rates are likely to stay clearly above 2% over the coming months. Thereafter, on the basis of the path implied by futures markets for oil prices, inflation rates should fall below 2% in 2012. This pattern reflects the expectation of relatively stable wage growth developments in the context of moderate economic growth.

The September 2011 ECB staff macroeconomic projections for the euro area embody these considerations and foresee annual HICP inflation in a range between 2.5% and 2.7% for 2011 and between 1.2% and 2.2% for 2012. In comparison with the June 2011 Eurosystem staff macroeconomic projections, the range for HICP inflation in 2011 remains unchanged, while the range for 2012 is slightly narrower.

The entire press conference here.


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