Trichet – “risks to the outlook for price developments are on the upside”

Jean-Claude Trichet, President of the European Central Bank (ECB), sees inflation and appears ready to try to do something about it. The challenge is how and when to raise interest rates when several countries in the eurozone are still struggling with issues over sovereign debt.

Here are some key inflation-related quotes from today’s statement on monetary policy at the ECB:

“The economic analysis indicates that risks to the outlook for price developments are on the upside, while the underlying pace of monetary expansion remains moderate.”

Trichet and the ECB are clearly portraying themselves as hawkish and officially on “inflation watch”:

“It is essential that the recent rise in inflation does not give rise to broad-based inflationary pressures over the medium term. Strong vigilance is warranted with a view to containing upside risks to price stability. Overall, the Governing Council remains prepared to act in a firm and timely manner to ensure that upside risks to price stability over the medium term do not materialise. The continued firm anchoring of inflation expectations is of the essence.”

The ECB appears determined not to let increases in commodity and food prices permeate throughout the larger economy:

“With regard to price developments, euro area annual HICP inflation was 2.4% in February 2011, according to Eurostat’s flash estimate, after 2.3% in January. The increase in inflation rates in early 2011 largely reflects higher commodity prices. Pressure stemming from the sharp increases in energy and food prices is also discernible in the earlier stages of the production process. It is paramount that the rise in HICP inflation does not lead to second-round effects and thereby give rise to broad-based inflationary pressures over the medium term. Inflation expectations over the medium to longer term must remain firmly anchored in line with the Governing Council’s aim of maintaining inflation rates below, but close to, 2% over the medium term.”

The ECB is hoping that modest growth in the money supply will restrain inflationary pressures:

“Looking beyond the movements in individual months and the effects of special factors, trends in broad money and loan growth confirm the assessment that the underlying pace of monetary expansion is still moderate and that inflationary pressures over the medium to longer term should remain contained. At the same time, the low level of money and credit growth has thus far led to only a partial unwinding of the large amounts of monetary liquidity accumulated in the economy prior to the period of financial tensions. This liquidity may facilitate the accommodation of price pressures currently emerging in commodity markets as a result of strong economic growth and ample liquidity at the global level.”

But just to make sure everyone understands loud and clear, the statement repeats the following commitment:

“Overall, the Governing Council remains prepared to act in a firm and timely manner to ensure that upside risks to price stability over the medium term do not materialise. The continued firm anchoring of inflation expectations is of the essence.”

Forecasters seem to be anticipating a rate hike in the next ECB meeting. The key from there is to see whether the accompanying statement hints at further rate hikes. Given the ECB’s very modest forecast for growth in the next two years, I suspect rate hikes will emphasize symbolism over quantity.

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Inflationary concerns rising amongst ECB members

In “Mersch Says ECB May Warn of Upside Inflation Risks Next Week”, Bloomberg reports that European Central Bank (ECB) council member Yves Mersch has added his concerns over inflation to a growing list of worried voices:

“Mersch is the fourth policy maker this week to signal increased unease about inflation. Executive Board member Juergen Stark said last night that the ECB is “prepared to act decisively and immediately if needed” to maintain price stability. Fellow board member Lorenzo Bini Smaghi said the bank may need to reassess its policy stance.”

Most importantly, Mersch indicated:

“I would not be surprised at most colleagues concluding that we have upside risks to price stability”

The biggest concern seems to be that increased food and energy prices will motivate labor unions to press for wage increases, thus stoking general inflationary pressures. Strong economic growth in Germany is also increasing the need for higher rates but lingering issues with sovereign debt in the periphery countries may yet prevent rate hikes.