Thursday, August 28, 2008

The Hawk Still Flies

Axel Weber, ECB's most prominent hawk recently said that interest rate cuts is out of the question, and that as soon as economic data becomes stronger, interest rates will in fact be raised.

The likely reason why he made these comments is that there seems again be increasing speculation in financial markets that the ECB will soon cut interest rates. Markets believed the same thing in the beginning of the year, but instead of a cutting rates, the ECB raised them. Again, the markets are likely to be proven wrong.

As it happens, these speculations are self-defeating. The recent decline in the euro's exchange rate and oil will likely have little effect on price inflation (with the weaker euro counteracting the effect of oil) while providing support for growth (with the weaker euro strengthening the effect of oil).

Weber's position is also the only one consistent with the ECB's mission. ECB has no mandate to try to provide short-term stimulus to the business cycle and is instead obliged to keep money supply growth below 4.5% and price inflation below 2%. With both money supply growth and price inflation being much higher than that, there is simply no room for interest rate cuts.


Anonymous Anonymous said...

From what I can see, the markets are very poor predictors of monetary policy shifts. In the US, the market had all-but bet on a Fed rate cut in Aug/Sept, but now, one month later, it won't happen until next year (like many Economists had predicted earlier).

The markets are increasingly irrational these days and trading on a whim. Unfortunately, for Europe, it is more of a story of hope for expansionary policy, which as you point out, is certainly self-defeating.

Thanks for the post, R

11:26 PM  

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