One of the subtleties of yesterday’s complex package from the European Central Bank was that it attempted to re-assert the principle of “separation”. When the financial storm broke in August 2007, the ECB insisted, doggedly, that emergency financial market liquidity injections were not related to its monetary policy. That remained firmly aimed at controlling inflation and still very much determined the level at which it set the main policy interest rate. Indeed, in July last year the ECB famously raised the interest rate to 4.25 per cent because inflation appeared to be getting out of control.
After the collapse of Lehman Brothers a few months later, the ECB slashed its main policy rate and the distinction became harder to draw. It became impossible once, from June this year, the ECB started offering unlimited one-year liquidity at the main policy rate – that is, just one per cent. Financial markets assumed the main interest rate would remain unchanged over the lifetime of the loans.
That has now changed. The interest rate on this month’s offer of one-year liquidity will be be linked to future changes in the main policy rate, which will thus be easier to vary according to inflation risks.
At the moment, of course, eurozone inflation looks very subdued – the latest ECB forecasts show it undershooting in 2010 and 2011 the target of an annual rate “below but close” to 2 per cent. So an obvious question, yesterday, why was the ECB implementing its “exit strategy” when, surely, it should be maintaining an ultra-loose policy? The response of Jean-Claude Trichet, president, hinted at the separation principle. “We are not signalling anything in terms of a hardening of our monetary policy – absolutely nothing,” he said. But I wonder if ECB policymakers will want to make the distinction even clearer in the coming days?
