Daily Archives: April 8, 2011

Robin Harding

I’m pretty sure that the answer is ‘No’, at least for now. For background, the effective Fed Funds rate has been falling steadily for the last couple of months:


Ralph Atkins

The interest rate increase delivered by the European Central Bank this week was exactly as expected. But Jean-Claude Trichet, president, left observers scratching their heads over other items on Thursday’s ECB governing council’s agenda.

First, were plans to deal with the problem of ”addicted banks” – those banks which have become dependent on ECB liquidity. Several council members (including Italy’s Mario Draghi) had spoken publicly about proposals to limit the use of ECB operations by individual banks. The assumption was that some kind of penalties would be imposed.

Mr Trichet noted on Thursday, however, that the problem had changed “in nature over time”. 

The ECB decision to raise its policy rate by 0.25 per cent to 1.25 per cent is a seminal moment for the global economy. Not only is this the first of the leading central banks to raise rates, it is the first time for decades that Europe has initiated a rate rising cycle ahead of its counterparts at the Fed. I believe that it is wrong to view this as an isolated occurrence: economic fundamentals are far more supportive of rate rises in the eurozone than they are in the US, and that will remain the case for some time to come. And the ECB is deliberately sending a very strong message to member states that they have not gone far enough to fix the sovereign debt problem. Although the markets have already to some extent anticipated the front-loading of ECB rates, relative to those set by the Fed, they may not yet have moved far enough in that direction.

The main reason for today’s rate rise is of course entirely obvious. Eurozone inflation has persistently come in higher than expected in recent months, and the headline CPI rate reached 2.6 per cent in March, mainly because of higher oil prices. Since the ECB tends to be more influenced by the headline inflation rate, while the Fed places more emphasis on the (much lower) core rate, it was always likely that the two central banks would react in different ways to a commodity price shock.

However, this is not the only reason for the ECB’s greater hawkishness. The Fed (rightly in my view) is convinced that there is still plenty of spare capacity left in the US economy, because the unemployment rate remains far above the equilibrium or structural rate of unemployment. By contrast, the ECB is less confident about the margin of spare capacity in the European economy.