Situation 
(click / double click on chart to get the bigger picture)
At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:
- The minimum bid rate on the main refinancing operations of the Eurosystem will be increased by 25 basis points to 3.75%, starting from the operation to be settled on 14 March 2007.
- The interest rate on the marginal lending facility will be increased by 25 basis points to 4.75%, with effect from 14 March 2007.
- The interest rate on the deposit facility will be increased by 25 basis points to 2.75%, with effect from 14 March 2007.
Jean-Claude Trichet, President of the ECB - says that ” This decision was taken in view of the upside risks to price stability over the medium term that we have identified through both our economic and monetary analyses “. He added that growth rate of GDP in the Euro area for Q4 2006 was above previous expectations. ( 3.28% p.a)
He further states ” In comparison with the December Eurosystem staff projections, the ranges projected for real GDP growth in 2007 and 2008 have been revised upwards, largely reflecting the strength of GDP growth in the second half of 2006 and the lower energy prices, which, if sustained, would have a positive impact on real disposable income”. The projections foresee average annual real GDP growth in a range between 2.1% and 2.9% in 2007 and between 1.9% and 2.9% in 2008
The Bank concluded “in assessing price trends it is important to look through any short-term volatility in inflation rates. The relevant horizon for monetary policy is the medium term.” . i.e they believe that the recent drops in inflation - are not sustainable.
The Banks view is that the fall in headline inflation rates since the summer of 2006 has been predominantly due to lower energy prices and expressed fear that the main risks relate to the possibility of a renewed increase in oil prices, fears of a rise in protectionist pressures and concerns about possible disorderly developments owing to global imbalances.
Points to Note :
- The European Commercial bank ( ECB) aims at inflation ( CPI ) rates of below, but close to, 2% over the medium term. They have achieved this primary goal.
Inflation - both the Consumer Price Index (CPI) - 1.8 % p.a in January 2006 as well as the Producer Price Index has been dropping since mid 2006. Am not sure if thats exactly a ”short term”.
- Euro GDP has grown by 3.28 % p.a in Q4 2006. The Bank has cited ” unexpected growth” as a reasoning that growth is healthy ( ergo interest rate hikes can be easily absorbed).
Consider the following :
- The New Orders Index - which was doing extremely well in October and November’06 has had a sharp drop in orders in December 2006 ( seasonaly adgusted ). It does look like this drop may be “sustained” .
- This drop in New Orders can be expected to start effecting the Industrial Production from January - February ‘07 onwards . The Industrial Production Index does look like its peaking and could start dropping
- The interest rate has been hiked two times since December’06 - totaling up to 0.5% p.a.
While the GDP growth for Q1 2007 may not get effected - the real effects of this may be from Q2-Q3 2007 onwards. Am not sure for how long the GDP growth will remain “sustainable” given the above situations. ( of course the Bank has added a further clause - depending on ” lower energy prices,which, if sustained……”).
- In one part of the statement the Bank justifies the interest rate hike citing “main risks relate to the possibility of a renewed increase in oil prices”
In another part of the statement the Bank says that “lower energy prices, which, if sustained…” would allow growth rate in GDP to be sustainable and could absorb the interest rate hike.
- In the current economic situation :
- The USA has started experiencing drops in growth of New Orders as well as Production .
- Japan has been experiencing drops in New Orders as well as in Production.
- UK has begun experiencing a slowdown in Production.
- China in its latest Budget has stated that they would like to slowdown.
Conclusion
Maybe the ECB raised the rates because ” they said they would” ( pretty bureaucratic) - and the markets had already discounted this ?
- If controlling inflation was the target - the Bank has already achieved the stated target.
- If stunting GDP growth - for the Q3 2007 onwards - is the target - that too the Bank could achieve.
IF the Bank thinks it has a clue about the “medium term future” all that can be said is - read what Alan Greenspan thinks about - Econometric models. While Mr Greenspan always had a view towards the future , he always made his monetary policy decisions based on the current situation ( and within that simplicity - lay the brilliance).
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