ECB's obsession with inflation
Does raising interest rates in the present circumstances, as the European Central Bank in its professional wisdom did on Thursday, make sense? In my opinion, the decision announced by bank president Jean-Claude Trichet will only aggravate the existing...
Does raising interest rates in the present circumstances, as the European Central Bank in its professional wisdom did on Thursday, make sense? In my opinion, the decision announced by bank president Jean-Claude Trichet will only aggravate the existing economic situation.
The ECB, its president demonstrated very clearly, is worried about rising inflation. That is why Mr Trichet shocked the markets by signalling some days before Thursday that the bank would be making its first central rate increase in over a year, the rate having been raised to 4 per cent in June 2007.
Inflation is certainly on the increase. It recently hit 4 per cent in the eurozone area, on a year-to-year basis. That is the highest it has reached since the introduction of the euro as the zone's common currency in 1999. That is more than double the ECB's target of an annual rate of "below but close to" 2 per cent, as the institution puts it.
Analysts observe that the adjusted eurozone inflation was last higher than 4 per cent as far back as May 1992.
Controlling inflation is the ECB's basic objective. But should that objective be followed so slavishly? There is no inflationary increase in demand to deflate in the eurozone. The contrary is true. Like much of the rest of the world that area is experiencing a sharp drop in growth prospects, with accompanying signs that, in various member states, unemployment will increase. A few examples drive the point home.
Ireland had been the best performing economy in the eurozone for the past decade, with real growth averaging a remarkable 7.2 per cent annually. The government has now had to slash its December forecast of 3 per cent growth in 2008 to a puny 0.5 per cent, one half of a percentage point. The main cause has been a sharp correction in the property market. The prospect of rising unemployment is dulling Irish eyes.
On the mainland eurozone Denmark became the first economy in the region to stumble into what is called technical recession - two successive quarters of negative growth. The Danish economy shrank by 0.6 per cent in the December quarter of 2007, and by a further 0.2 per cent in the January-March period of 2008.
Another shining star of the eurozone - Spain - has pulled on a very gloomy face. Spanish gross domestic product stopped growing in the April-June 2008 quarter, according to provisional estimates. Once again, that was due to a slowdown in the housing sector. As a result the Spanish economy is no longer creating jobs. Unemployment is higher than it has ever been since April 2008.
Becoming the top football team in Europe after defeating the dogged Germans, and being made number one in the whole wide world, plus Nadal winning Wimbledon has lifted Spanish spirits. It will do little for the employment situation, now that the victory revelry is past.
The downturns in the three countries, together with sectoral declines in Germany and elsewhere, are clear indicators that the eurozone economy has lost its zest and is slowing down. With that worrying factor in place alongside rising inflation, the eurozone is set to experience stagflation, one of the most worrying economic conditions that can hit a country or an economic area.
That notwithstanding, the European Central Bank has gone ahead with the threat signalled by Mr Trichet, and acted to push up the interest rate structure in the region. The resulting higher interest rates will simply raise production costs and final prices. At a time when the world economy is in clear downturn, that reads like madness.
More kindly it reflects the ECB's obsession with the rate of inflation, even though higher interest rates cannot dampen the inflationary effect of the soaring price of crude oil and its derivatives, and of food.
The decision taken last Thursday, needless to say, affects Malta as well, as one of the younger members of the eurozone. Here too the economy is weakening. There remain expanding areas, which helped produce decent growth in the first quarter, according to early estimates. But there are sectors which are feeling a great pinch.
The housing sector, with sales all but dead, is the main one, though building goes on apace as developers demonstrate a remarkable willingness to defy economic gravity.
The upward shift in borrowing costs will not be the last straw. But it will not help. The loss of control over our domestic monetary policy is one of the costs of being part of a monetary union, hopefully offset by the positives on a net basis.
At least Mr Trichet is not indicating that other interest hikes are imminent. He did stress that, if the ECB did not act decisively there was a risk of inflation exploding. But so far euro-analysts suggest that, reading between the lines and the body language, the eurozone's central bank is unlikely to raise interest rates soon.
With oil and food prices set to move up further, that alone will restrain consumption without the need of further, assistance. But such accelerating prices will also continue to pump up inflation. There is no saying that ECB's obsession with its target inflation mandate will not push it towards further madness, sooner rather than later, whatever tiny growth and growing unemployment numbers say.
The ECB, its president demonstrated very clearly, is worried about rising inflation. That is why Mr Trichet shocked the markets by signalling some days before Thursday that the bank would be making its first central rate increase in over a year, the rate having been raised to 4 per cent in June 2007.
Inflation is certainly on the increase. It recently hit 4 per cent in the eurozone area, on a year-to-year basis. That is the highest it has reached since the introduction of the euro as the zone's common currency in 1999. That is more than double the ECB's target of an annual rate of "below but close to" 2 per cent, as the institution puts it.
Analysts observe that the adjusted eurozone inflation was last higher than 4 per cent as far back as May 1992.
Controlling inflation is the ECB's basic objective. But should that objective be followed so slavishly? There is no inflationary increase in demand to deflate in the eurozone. The contrary is true. Like much of the rest of the world that area is experiencing a sharp drop in growth prospects, with accompanying signs that, in various member states, unemployment will increase. A few examples drive the point home.
Ireland had been the best performing economy in the eurozone for the past decade, with real growth averaging a remarkable 7.2 per cent annually. The government has now had to slash its December forecast of 3 per cent growth in 2008 to a puny 0.5 per cent, one half of a percentage point. The main cause has been a sharp correction in the property market. The prospect of rising unemployment is dulling Irish eyes.
On the mainland eurozone Denmark became the first economy in the region to stumble into what is called technical recession - two successive quarters of negative growth. The Danish economy shrank by 0.6 per cent in the December quarter of 2007, and by a further 0.2 per cent in the January-March period of 2008.
Another shining star of the eurozone - Spain - has pulled on a very gloomy face. Spanish gross domestic product stopped growing in the April-June 2008 quarter, according to provisional estimates. Once again, that was due to a slowdown in the housing sector. As a result the Spanish economy is no longer creating jobs. Unemployment is higher than it has ever been since April 2008.
Becoming the top football team in Europe after defeating the dogged Germans, and being made number one in the whole wide world, plus Nadal winning Wimbledon has lifted Spanish spirits. It will do little for the employment situation, now that the victory revelry is past.
The downturns in the three countries, together with sectoral declines in Germany and elsewhere, are clear indicators that the eurozone economy has lost its zest and is slowing down. With that worrying factor in place alongside rising inflation, the eurozone is set to experience stagflation, one of the most worrying economic conditions that can hit a country or an economic area.
That notwithstanding, the European Central Bank has gone ahead with the threat signalled by Mr Trichet, and acted to push up the interest rate structure in the region. The resulting higher interest rates will simply raise production costs and final prices. At a time when the world economy is in clear downturn, that reads like madness.
More kindly it reflects the ECB's obsession with the rate of inflation, even though higher interest rates cannot dampen the inflationary effect of the soaring price of crude oil and its derivatives, and of food.
The decision taken last Thursday, needless to say, affects Malta as well, as one of the younger members of the eurozone. Here too the economy is weakening. There remain expanding areas, which helped produce decent growth in the first quarter, according to early estimates. But there are sectors which are feeling a great pinch.
The housing sector, with sales all but dead, is the main one, though building goes on apace as developers demonstrate a remarkable willingness to defy economic gravity.
The upward shift in borrowing costs will not be the last straw. But it will not help. The loss of control over our domestic monetary policy is one of the costs of being part of a monetary union, hopefully offset by the positives on a net basis.
At least Mr Trichet is not indicating that other interest hikes are imminent. He did stress that, if the ECB did not act decisively there was a risk of inflation exploding. But so far euro-analysts suggest that, reading between the lines and the body language, the eurozone's central bank is unlikely to raise interest rates soon.
With oil and food prices set to move up further, that alone will restrain consumption without the need of further, assistance. But such accelerating prices will also continue to pump up inflation. There is no saying that ECB's obsession with its target inflation mandate will not push it towards further madness, sooner rather than later, whatever tiny growth and growing unemployment numbers say.