Trichet’s troubling interest rate hike

So Jean-Claude Trichet, head of the European Central Bank, has decided to raise the Eurozone’s main interest rate for lending from 1% to 1.25%. The last increase was back in July 2008. Hikes to 1.75% are expected by the end of the year.

The nominal reason? Fear of inflation and notably of prices and wages going up in response to the rise in commodity prices. However, the WSJ blog notes that “Mr. Trichet acknowledged there is little evidence for this behavior thus far, so the ECB’s 0.25% rate hike appears to be preemptive, an effort to show its determination to prevent higher commodity prices from becoming embedded in wages, sparking the dreaded wage-price spiral.”

Perhaps the most perplexing thing is how at odds the ECB’s behavior is everyone else’s. As economist at the Sorbonne Christian de Boissieu tells Jean Quatremer:

It’s a paradox: the Eurozone is the economic space with the most moderate recovery and the strongest exchange rate, it’s the one which went the least far in lowering [interest] rates and will be the first to increase them.

One gets the impression that the ECB thinks it can operate outside, not just of a political context which is considered a “feature” of an independent bank, but outside the social and economic context of Europe’s wildly uneven recovery and outside of an international context where the Euro is cripplingly overvalued relative to the British pound, the U.S. dollar and the Chinese Yuan. For reference, in the American and Japanese central banks have gone with zero as their main rate.

The rise in commodity prices does not seem related to monetary policy but rather to more objective factors, notably, demand outstripping supply, a trend that will only continue as the emerging nations’ consumption habits approach Western levels (notably in food and transport). Meanwhile, how are the “troubled periphery” countries supposed to boost exports, outgrow their debt and refinance in these conditions? Can the Euro remain credible if individual nations – Spain, Portugal, Ireland – quite reasonably come to the conclusion that it is ruining them?

Der Spiegel has an article almost too true to form: lots of fretting about inflation and arguing the rate doesn’t go far enough for Germany. And another notes that “most” European economies are recovering but one would have to add what this is supposed to mean to people if by “recovery” one doesn’t mean “rise in employment”. The Eurozone unemployment rate has hardly budged in a year, it was 10% in February 2010, exactly one year later it was… 9.9%. (The figure for the EU27 is 9.6%.)

To those who are satisfied with the technical definition of recovery, I point them to one of Ronald Reagan’s  economic bon mots: “A recession is when your neighbor loses his job. A depression is when you lose yours.*” An economic recovery is no good if by “economic recovery” you mean something which doesn’t improve people’s livelihood!

* Reagan added: “And a recovery is when Jimmy Carter loses his!”

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One Response to Trichet’s troubling interest rate hike

  1. CNY in JPY says:

    The market eagerly awaits this speech as Trichet may deliver some farther clues on future rate hikes and on where the currency is heading. CNY in JPY

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