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Is it risky to fight with inflation under these circumstances?
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The European Central Bank's apparent resolve to make a pre-emptive strike on inflation by raising interest rates is, to put it mildly, a strategy not without risk.
Seeking to head off the dreaded second-round effects, whereby surging prices for energy and food are translated into higher wages and otherwise entrench themselves, the bank has more or less announced that it will up rates at its next opportunity in July.
With only inconclusive evidence that inflation is becoming embedded, a hike will punish a creaking banking system, make credit harder to come by and squelch growth.
And if there is anything we've learned in the past few years it is that pre-emptive strikes based on incomplete information can have big and long lasting consequences.
Firms don't have the pricing power and consumers don't have the money.You are hitting this economy with a strong euro, consumers are seeing their purchasing power eroded by higher fuel and food prices and house prices are falling in several countries. On top of that you have a global slowdown and then you put in higher costs of credit. You are going to stamp on growth.
To be fair to the ECB, they are in a difficult position and the opposite course would be painful and risky too.
The ECB is forecasting inflation of about 3.4 percent this year, well above its ceiling of 2 percent, energy and food prices show no signs of moderating and there have been some inflation busting wage agreements in Germany.
But a particular concern is what a hike does to the banking system, which in Europe has been arguably less successful than its U.S. counterpart in raising new capital and healing itself.
One of the side effects of the ECB's announcement was a stunning inversion of the yield curve, as two-year interest rates shot higher to discount higher rates in the near term and ten year ones fell before recovering, reflecting doubts among investors about the growth outlook. Two year eurozone bonds were about ten basis points higher than ten year ones on Tuesday and were as much as 40 basis points higher earlier in the week.
The impact of an inversion on banks, if sustained, is significant, in that banks borrow short and lend long. An inverted yield curve removes one motivation for lending and also an easy way for banks to make profits and build up their capital. Simply put, it should tighten credit.
PLENTY OF CREDIT OR PLENTY OF FORCED LENDING?
The ECB has taken comfort from statistics showing hefty growth in corporate and other lending, arguing that it shows a limited real impact from the banking crisis.
And indeed the statistics are remarkable, especially given that banks are telling the ECB in the loan officer's survey that they are tightening and rationing credit aggressively.
Corporate lending in the eurozone grew 15 percent in the year to April, while overall credit growth was up 9.7 percent, neither figures that, on the face of it, indicate a credit crunch.
But there is reason to believe those figures are a sign of weakness and duress rather than a healthy banking system playing its part.
As many corporations are effectively shut out of capital markets that are now all but closed, they will have been drawing down on existing standby credit agreements put in place before the crisis hit last summer. These are not loans that either side ever hoped would be drawn, and while the borrowers are probably happy to have money on terms that now look cheap, the banks will not be. When these deals come up for renegotiation, expect higher rates, fewer loans and suppressed growth.
While it is certainly possible that the ECB will be proved correct, raising rates in such a fragile situation could prove an expensive form of inflation insurance.
Albert Edwards, global strategist at Societe Generale in London, is not alone in comparing the ECB's move to events that preceded the crash of 1987, when a hike in German interest rates upset the applecart.
"On one interpretation, fearing that the German rate hike might cause a renewed plunge in the dollar and force recessionary Fed rate hikes, the Dow collapsed," Edwards wrote in a note to clients.
This time, verbal support from the Fed has supported the dollar and there has been a notable and concerted round of tough talking on inflation from the U.S. However, if it becomes apparent that the Fed cannot or will not raise rates this year then those noises may become less effective.
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| Tarih
: 6/15/2008 |
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Copyright
© 2006 Mert TOKER All Rights Reserved. |
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