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    [ID] => 4326
    [post_author] => 13219
    [post_date] => 2007-11-18 20:51:31
    [post_date_gmt] => 2007-11-18 19:51:31
    [post_content] => The most recent data on inflation in the euro zone puts the European Central Bank in a very difficult situation in relation to its decisions regarding interest rates. The average 2.6% is well above the objective of maintaining inflation close but below 2%.  There are probably many factors explaining this result, among them of course oil prices are important. Now, when we take into account that the ECB has a very clear quantitative objective in terms of inflation, then technically we could assume that the ECB is almost forced to increase interest rates to try to contain these inflationary pressures. However, the overall picture is not as simple.

In the first place, the euro zone average is including a wide variation in terms of individual data. The range goes from 1.6% inflation in the Netherlands to 5.1% inflation in Slovenia. On the upper side, after Slovenia appear Spain and Luxembourg, both with 3.6%, and then Greece and Ireland with 3%. For all of these countries an increase in interest rates may help fighting inflation, although the expected effects in terms of a relative slowdown of the economy may not be desired, in particular in a global context  of uncertainty and with weak housing markets that could be threatened by higher interest rates.


On the other side of the range we can find Finland, with 1.8%, and France, with 2.1% following the Netherlands.  Among other large countries, Italy is showing an inflation of 2.3% and Germany is relatively high at 2.7%. When we see these numbers, we could think that it is clear that the ECB should increse interest rates if it is to be truthful to its mission.  But this would be true under normal conditions, and the present environment is quite far from being "normal". The world is going through a period of strong uncertainty and even though the full effects of the slowdown of the United States over its own economy and over the rest of the world remain to be seen, it is not an adequate moment to "contain" growth. Almost all forecasts are anticipating a reduction on growth in Europe, and implementing policies that would reinforce this trend, even if they would help controlling inflation, may not be easy to understand for most of the population. But there is another factor that is most likely being taken into consideration.

Higher interest rates in the euro zone would decrease the differential with US interest rates, and that would strengthen the euro, which, as we all know, is already very strong. With some European countries already complaining about a euro that is too strong, it is likely that the ECB would come under fire if its policies are thought to be contributing to containing exports, and therefore growth, of the euro zone. So the European Central Bank is facing a difficult environment, and it seems that perhaps it may be facing one of those "loose-loose" situation. No matter what they do they will be accused of failing. If they increase interest rates and have some success in containing inflation they may be blamed for hurting growth in general, and exports in particular if the euro continues to strengthen. If they do not increase interest rates they may be accused of not being able to fight against inflation. And, if they decrease interest rates, which seems unlikely given the latest data on inflation, they could be accussed of feeding inflation. Not an easy time for the ECB.

    [post_title] => Difficulties ahead for the European Central Bank
    [post_excerpt] => 

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    [post_name] => difficulties_ah
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    [post_modified] => 2023-12-13 13:54:59
    [post_modified_gmt] => 2023-12-13 12:54:59
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The most recent data on inflation in the euro zone puts the European Central Bank in a very difficult situation in relation to its decisions regarding interest rates. The average 2.6% is well above the objective of maintaining inflation close but below 2%. There are probably many factors explaining this result, among them of course oil prices are important. Now, when we take into account that the ECB has a very clear quantitative objective in terms of inflation, then technically we could assume that the ECB is almost forced to increase interest rates to try to contain these inflationary pressures. However, the overall picture is not as simple.

In the first place, the euro zone average is including a wide variation in terms of individual data. The range goes from 1.6% inflation in the Netherlands to 5.1% inflation in Slovenia. On the upper side, after Slovenia appear Spain and Luxembourg, both with 3.6%, and then Greece and Ireland with 3%. For all of these countries an increase in interest rates may help fighting inflation, although the expected effects in terms of a relative slowdown of the economy may not be desired, in particular in a global context of uncertainty and with weak housing markets that could be threatened by higher interest rates.

On the other side of the range we can find Finland, with 1.8%, and France, with 2.1% following the Netherlands. Among other large countries, Italy is showing an inflation of 2.3% and Germany is relatively high at 2.7%. When we see these numbers, we could think that it is clear that the ECB should increse interest rates if it is to be truthful to its mission. But this would be true under normal conditions, and the present environment is quite far from being «normal». The world is going through a period of strong uncertainty and even though the full effects of the slowdown of the United States over its own economy and over the rest of the world remain to be seen, it is not an adequate moment to «contain» growth. Almost all forecasts are anticipating a reduction on growth in Europe, and implementing policies that would reinforce this trend, even if they would help controlling inflation, may not be easy to understand for most of the population. But there is another factor that is most likely being taken into consideration.

Higher interest rates in the euro zone would decrease the differential with US interest rates, and that would strengthen the euro, which, as we all know, is already very strong. With some European countries already complaining about a euro that is too strong, it is likely that the ECB would come under fire if its policies are thought to be contributing to containing exports, and therefore growth, of the euro zone. So the European Central Bank is facing a difficult environment, and it seems that perhaps it may be facing one of those «loose-loose» situation. No matter what they do they will be accused of failing. If they increase interest rates and have some success in containing inflation they may be blamed for hurting growth in general, and exports in particular if the euro continues to strengthen. If they do not increase interest rates they may be accused of not being able to fight against inflation. And, if they decrease interest rates, which seems unlikely given the latest data on inflation, they could be accussed of feeding inflation. Not an easy time for the ECB.