By Claus Vistesen Copenhagen
This is really just an update relative to my post yesterday talking about today's ECB meeting. As expected, the decision amounted to a holding operation (Q&A here) but more interestingly was the fact that Trichet and his colleagues still seem stubbornly persistent on retaining what they denote as a tightening bias or more specifically they are reserving their real option to act upon inflation. The following from Trichet's introductory statement sums up today's message ...
To sum up, a cross-check of the outcome of the economic analysis with that of the monetary analysis fully confirms the assessment that there are upside risks to price stability over the medium term, in a context of very vigorous money and credit growth and sound economic fundamentals in the euro area. At the same time, the potential impact on the real economy of the ongoing reappraisal of risk in financial markets remains uncertain. Consequently, we will monitor very closely all developments. The Governing Council remains prepared to act pre-emptively so that second-round effects and upside risks to price stability do not materialise and, consequently, medium and long-term inflation expectations remain firmly anchored in line with price stability. Reflecting its mandate, such anchoring is of the highest priority to the Governing Council.
There are a few things to note here I think. The first thing is the simple question as to when the ECB's Governing Council will start to pay attention to events in the real world. Ok, full stop here! It is indeed true that inflation forms a part of this real world picture and it is also true that the mandate by which the council is put into being is anchored in the maintenance of price stability. However, another part of the story is then that we are now dealing with the prospect of a Eurozone wide slowdown which is becoming clearer by the day. So, we can all see the tradeoff and no-one is saying that it is going to be pretty either way. But there are two issues in particular which I think are missing in the general account. The first is the idea that the Eurozone is not excluded from the rest of the world. De-coupling à la traditionelle has been weighed and found wanting and the ECB's policy stance is a bet on de-coupling which just does not seem to fit with the fundamentals. Secondly, we have the inflation issue itself which I am sure anybody can agree is not to be treated lightly. However, I can't stop but feel that we are risking falling victim to tale about how it does little service to close the barn door and mend the fence once the horse has already evaded. In this way, it is a bold game to believe that you can wait until inflation has abated since then the horse will be thundering across your neighbour's meadows. In short, I see the ECB boxing itself in on this one and although cruise control can be a pleasant companion when the road is straight and the pavement smooth you need to put your foot on the clutch if you want to shift gears. Ok enough of my own personal sentiment here. What are the likely consequences of today's ECB (non)action?
In essence, it was not today that the ECB shifted its stance towards a more balanced look at the economy but when will it be then ... that is difficult to say. One thing is certain and that is that the longer we venture into 2008 the more implausible the ECB's 'vigiliance light' against inflation will sound. Coupled with the likely trajectory of the economic data and of course pending on the inflation readings I see a slight change at the next ECB meeting (although still a hold) which could pave the way for a cut at either the April or May session. As for the EUR/USD we now need to factor in that while Trichet has played his cards such as it is Bernanke is up next and this means that, contrary to what I noted yesterday (see first link in this post), we could see a sniff at 1.50. I maintain my view however that the fundamental bias for 2008 should be for a short EUR/USD position.