Monday, July 11, 2011

ECB Tightening Attempt Backfiring?

Last week's interest rate increase by the ECB was foolish for pretty much the same reasons as the previous one, reasons that I discussed here, mainly that money supply growth had in fact already dropped to zero in recent months (something that has continued since then), that increased risk aversion by increasing money demand also had deflationary effects and that the euro was trading at an elevated level. And by tightening monetary condititons at a time of debt panic is likely to aggravate that general panic.

The first interest rate increase was closely followed by increased panic around Portugal, now the second starts to create increased panic around Italy-though that isn't as serious as that regarding Portugal-yet.

But by aggrevating the debt panic, the ECB's move is in fact now sending the exchange rate of the euro lower as demand for euros relative other currencies fall-something that in turn could in fact raise price inflation, contrary to the ECB's stated objective.


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