Trichet Fights to Curb Pay Pressures as Inflation Accelerates
By - Feb 3, 2011 2:47 PM GMT+0300
Jean-Claude Trichet, president of the European Central Bank (ECB). Photographer: Hannelore Foerster/Bloomberg
Feb. 3 (Bloomberg) -- Laurent Fransolet, head of European fixed income strategy at Barclays Capital, talks about the future of the European Central Bank's bond purchase program. Fransolet also discussed Spanish bonds before an auction today with Francine Lacqua on Bloomberg Television's "On The Move." (Source: Bloomberg)
The euro-area rate rose to 2.4 percent in January, the highest in more than two years, workers are demanding bigger pay increases in Germany, where import-price inflation is running at the fastest pace in 29 years, and political tensions in Egypt are stoking oil prices. The risk for Trichet is that his inflation-fighting rhetoric convinces investors the ECB will raise borrowing costs before Europe overcomes its debt crisis.
“It is a balancing act,” said Jens Sondergaard, senior European economist at Nomura International Plc in London. “He’s trying to speak to the unions, but not spook the markets. There’s a careful fine-tuning of expectations going on.”
The euro surged and bonds fell after Trichet on Jan. 13 pledged to do what’s necessary to keep a rein on inflation, signaling a shift in focus for the ECB. While several policy makers subsequently tried to damp expectations for higher rates, Executive Board member Lorenzo Bini Smaghi reignited the debate last week with a warning that imported inflation can no longer be ignored.
The Frankfurt-based central bank will keep its benchmark interest rate at a record low of 1 percent today, according to all 58 economists in a Bloomberg News survey. The announcement is due at 1:45 p.m. and Trichet will hold a press conference 45 minutes later. The euro fell 0.3 percent against the dollar to $1.3764 as of 12:44 p.m. today before the decision.
‘Policy Mistake’
Trichet said last month that while the jump inflation is “temporary,” risks to the price outlook “could move to the upside.” That prompted investors to bring forward expectations for an ECB rate increase to as soon as the third quarter, Eonia forward contracts show.
Economists expect a move in the fourth quarter, before the Federal Reserve, which is forecast to raise rates in the first quarter of 2012, according to Bloomberg surveys.
“Many investors are concerned with the risk that the ECB makes a policy mistake and raises rates too soon,” said David Owen, managing director at Jefferies International Ltd. in London. “A key issue for the ECB should remain the likely pace of activity. The weaker the economic recovery, the more likely the pickup we are seeing in inflation proves temporary.”
ECB Exit
Europe’s debt crisis may damp growth as governments across the region cut spending to rein in deficits. While retail sales in the 17-nations currency bloc unexpectedly fell in December, euro-area services and manufacturing industries expanded at a faster pace than initially estimated in January, led by surging output growth in Germany and France, London-based Markit Economics said today.
European leaders meet in Brussels tomorrow to discuss bolstering their response to the crisis, including a proposal to allow the European Financial Stability Facility to purchase government bonds.
Such a step may allow the ECB to call a halt to its own bond-buying program and proceed with an exit from the emergency measures it’s been forced to implement.
‘Rumbling’ Crisis
“If the sovereign debt crisis can be laid to rest, the ECB will probably want to reduce its accommodative measures,” said James Nixon, co-chief European economist at Societe Generale SA in London. “But it would be tough for the ECB to raise rates if the crisis is still rumbling along in the background.”
While policy makers have stressed the ECB’s key rate remains “appropriate,” signaling they don’t intend to raise it soon, Bini Smaghi said last week that the bank can’t ignore the impact on inflation of “a permanent and repeated increase in the prices of imported products.”
German import-price inflation accelerated to 12 percent in December, driven by soaring costs for commodities such as energy. ECB Executive Board member Juergen Stark said on Jan. 26 that the bank will “act” if needed to counter so-called second-round effects, when workers demand pay increases to compensate for higher living costs.
German chemical workers are seeking up to 7 percent more pay, and the country’s IG Metall union has asked for a 6 percent increase for workers at companies including Volkswagen AG.
Some economists expect the ECB to raise its 2011 inflation forecast next month to more than 2 percent -- its definition of price stability -- as energy and food prices continue to rise.
‘Difficult’ Number
“That’s a difficult number to deal with, especially when you have interest rates as low as the ECB has,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London.
The ECB last raised interest rates in July 2008, just as the global financial crisis was brewing, in a warning to unions and households not to seek recompense for faster inflation.
While it was forced to cut rates aggressively just three months later, when the collapse of Lehman Brothers Holdings Inc. threw the world economy into its deepest slump since World War II, the ECB nevertheless proved its resolve.
“The inflation monster is looking in through the window again,” said Juergen Michels, an economist at Citigroup Inc. in London. “The ECB has shown it is prepared to act to keep it out.”
To contact the reporter on this story: Jeff Black in Frankfurt at jblack25@bloomberg.net
To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net
