ECB president Jean-Claude Trichet's rate retreat on commodity spike

 Jean-Claude Trichet said the jump in eurozone inflation to 2.4pc is a 'short-term' effect of rising energy and commodity costs Photo: Reuters

Jean-Claude Trichet, the ECB's president, set off sharp moves in currency and credit markets on Thursday as he sought to play down expectations of rate rises over coming months.

Mr Trichet said the jump in eurozone inflation to 2.4pc is a "short-term" effect of rising energy and commodity costs. "Our monetary analysis indicates that inflationary pressures over the medium to long term should remain contained. Inflation expectations remain firmly anchored At the same time, very close monitoring is warranted," he said. The ECB held rates at 1pc.

The euro tumbled almost two cents to $1.362 against the dollar, giving up a quarter of the gains it has made since Mr Trichet set off tremors last month with a red-hot inflation alert. Yields on the benchmark German Schatz or two-year bond plummeted 14 points to 1.34pc.

David Owen from Jefferies Fixed Income said Mr Trichet had carried out a deft pirouette. "Markets had priced in two rates this year after his comments in January, so he is now trying to put those expectations back in the box," he said.

Mr Owen said the ECB had learned a hard lesson when it over-reacted to the oil spike in the summer of 2008 by raising rates, even though Germany and Italy were already in recession by then and the global credit system was already starting to crumble.

"That was a major policy mistake. This time they are making the right judgment because there is no sign of credit growth in the eurozone, and the M2 money supply has started to contract again. The ECB must also be worried about the scale of deposit outflows from the Irish banking system," he said.

The ECB decision to "look through" the commodity spike brings the bank closer into line with the Bank of England and the US Federal Reserve, which has kept its focus on core inflation measures that strip out food and energy.

Yet is a risky move at a time when a powerful new cycle of global growth may be under way and the whole nexus of commodities is on fire. March contracts for Brent crude oil jumped to a two-year high of $103 a barrel on Thursday, while copper broke through $10,000 a tonne and cotton reached the highest price since the US Confederacy halted exports during the Civil War in the 1860s.

The UN's Food and Agriculture Organization (FAO) said its index of global food prices had hit a fresh record in January, while Goldman Sachs's farm index has risen 90pc since June.

Abdolreza Abbassian, the FAO's grain expert, said there is no sign yet that the "upward pressure" on world food prices is abating. "These high prices are likely to persist in the months to come," he said.

The uprisings in Tunisia and Egypt leave no doubt that the food shock has become a threat to social stability in much of the Middle East and possibly Asia. Food prices make up 50pc of the inflation index in the Philippines, and 37pc in China. It is less clear what the commodity shock means for the richer Atlantic world.

The current situation is unprecedented since excess global liquidity is flowing to the overheating economies of China, India, Brazil and the emerging powers, while parts of the West remain stuck in a "liquidity trap" with sluggish growth.

It is hard for Western central banks to calibrate policy in this new world order since their economies are no longer the driving force in commodity markets, unlike the 1970s when it was their own excess stimulus that set off the commodity spiral.

Rising resource prices in today's radically changed circumstances act as a tithe on US and European consumers and industry that must be paid to Mid-East petro-powers or Russian metal barons. This can have a deflationary impact, implying that moves to counter the effect by raising rates would make matters worse.

Germany's booming export sector has helped revive the eurozone over recent months but the Bundesbank forecasts a sharp slowdown in German growth this year, while the IMF expects fiscal tightening to delay recovery in Spain, Greece, Portugal and Ireland until 2012.

Eurozone retail sales have fallen for two months in a row, dropping 0.6pc in December. "Risks to the economic outlook are still slightly tilted to the downside," said Mr Trichet.

Veteran ECB watchers cautioned against reading too much into Mr Trichet's apparent retreat on inflation. Ken Wattret from BNP Paribas said there was a coded warning in the ECB's statement about upward pressure on prices in the "earlier stages of the production process", a precursor to inflation.

The German-led hawks at the ECB have not capitulated yet.

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ECB president Jean-Claude Trichet's rate retreat on commodity spike

 Jean-Claude Trichet said the jump in eurozone inflation to 2.4pc is a 'short-term' effect of rising energy and commodity costs Photo: Reuters

Jean-Claude Trichet, the ECB's president, set off sharp moves in currency and credit markets on Thursday as he sought to play down expectations of rate rises over coming months.

Mr Trichet said the jump in eurozone inflation to 2.4pc is a "short-term" effect of rising energy and commodity costs. "Our monetary analysis indicates that inflationary pressures over the medium to long term should remain contained. Inflation expectations remain firmly anchored At the same time, very close monitoring is warranted," he said. The ECB held rates at 1pc.

The euro tumbled almost two cents to $1.362 against the dollar, giving up a quarter of the gains it has made since Mr Trichet set off tremors last month with a red-hot inflation alert. Yields on the benchmark German Schatz or two-year bond plummeted 14 points to 1.34pc.

David Owen from Jefferies Fixed Income said Mr Trichet had carried out a deft pirouette. "Markets had priced in two rates this year after his comments in January, so he is now trying to put those expectations back in the box," he said.

Mr Owen said the ECB had learned a hard lesson when it over-reacted to the oil spike in the summer of 2008 by raising rates, even though Germany and Italy were already in recession by then and the global credit system was already starting to crumble.

"That was a major policy mistake. This time they are making the right judgment because there is no sign of credit growth in the eurozone, and the M2 money supply has started to contract again. The ECB must also be worried about the scale of deposit outflows from the Irish banking system," he said.

The ECB decision to "look through" the commodity spike brings the bank closer into line with the Bank of England and the US Federal Reserve, which has kept its focus on core inflation measures that strip out food and energy.

Yet is a risky move at a time when a powerful new cycle of global growth may be under way and the whole nexus of commodities is on fire. March contracts for Brent crude oil jumped to a two-year high of $103 a barrel on Thursday, while copper broke through $10,000 a tonne and cotton reached the highest price since the US Confederacy halted exports during the Civil War in the 1860s.

The UN's Food and Agriculture Organization (FAO) said its index of global food prices had hit a fresh record in January, while Goldman Sachs's farm index has risen 90pc since June.

Abdolreza Abbassian, the FAO's grain expert, said there is no sign yet that the "upward pressure" on world food prices is abating. "These high prices are likely to persist in the months to come," he said.

The uprisings in Tunisia and Egypt leave no doubt that the food shock has become a threat to social stability in much of the Middle East and possibly Asia. Food prices make up 50pc of the inflation index in the Philippines, and 37pc in China. It is less clear what the commodity shock means for the richer Atlantic world.

The current situation is unprecedented since excess global liquidity is flowing to the overheating economies of China, India, Brazil and the emerging powers, while parts of the West remain stuck in a "liquidity trap" with sluggish growth.

It is hard for Western central banks to calibrate policy in this new world order since their economies are no longer the driving force in commodity markets, unlike the 1970s when it was their own excess stimulus that set off the commodity spiral.

Rising resource prices in today's radically changed circumstances act as a tithe on US and European consumers and industry that must be paid to Mid-East petro-powers or Russian metal barons. This can have a deflationary impact, implying that moves to counter the effect by raising rates would make matters worse.

Germany's booming export sector has helped revive the eurozone over recent months but the Bundesbank forecasts a sharp slowdown in German growth this year, while the IMF expects fiscal tightening to delay recovery in Spain, Greece, Portugal and Ireland until 2012.

Eurozone retail sales have fallen for two months in a row, dropping 0.6pc in December. "Risks to the economic outlook are still slightly tilted to the downside," said Mr Trichet.

Veteran ECB watchers cautioned against reading too much into Mr Trichet's apparent retreat on inflation. Ken Wattret from BNP Paribas said there was a coded warning in the ECB's statement about upward pressure on prices in the "earlier stages of the production process", a precursor to inflation.

The German-led hawks at the ECB have not capitulated yet.

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ECB president Jean-Claude Trichet's rate retreat on commodity spike

 Jean-Claude Trichet said the jump in eurozone inflation to 2.4pc is a 'short-term' effect of rising energy and commodity costs Photo: Reuters

Jean-Claude Trichet, the ECB's president, set off sharp moves in currency and credit markets on Thursday as he sought to play down expectations of rate rises over coming months.

Mr Trichet said the jump in eurozone inflation to 2.4pc is a "short-term" effect of rising energy and commodity costs. "Our monetary analysis indicates that inflationary pressures over the medium to long term should remain contained. Inflation expectations remain firmly anchored At the same time, very close monitoring is warranted," he said. The ECB held rates at 1pc.

The euro tumbled almost two cents to $1.362 against the dollar, giving up a quarter of the gains it has made since Mr Trichet set off tremors last month with a red-hot inflation alert. Yields on the benchmark German Schatz or two-year bond plummeted 14 points to 1.34pc.

David Owen from Jefferies Fixed Income said Mr Trichet had carried out a deft pirouette. "Markets had priced in two rates this year after his comments in January, so he is now trying to put those expectations back in the box," he said.

Mr Owen said the ECB had learned a hard lesson when it over-reacted to the oil spike in the summer of 2008 by raising rates, even though Germany and Italy were already in recession by then and the global credit system was already starting to crumble.

"That was a major policy mistake. This time they are making the right judgment because there is no sign of credit growth in the eurozone, and the M2 money supply has started to contract again. The ECB must also be worried about the scale of deposit outflows from the Irish banking system," he said.

The ECB decision to "look through" the commodity spike brings the bank closer into line with the Bank of England and the US Federal Reserve, which has kept its focus on core inflation measures that strip out food and energy.

Yet is a risky move at a time when a powerful new cycle of global growth may be under way and the whole nexus of commodities is on fire. March contracts for Brent crude oil jumped to a two-year high of $103 a barrel on Thursday, while copper broke through $10,000 a tonne and cotton reached the highest price since the US Confederacy halted exports during the Civil War in the 1860s.

The UN's Food and Agriculture Organization (FAO) said its index of global food prices had hit a fresh record in January, while Goldman Sachs's farm index has risen 90pc since June.

Abdolreza Abbassian, the FAO's grain expert, said there is no sign yet that the "upward pressure" on world food prices is abating. "These high prices are likely to persist in the months to come," he said.

The uprisings in Tunisia and Egypt leave no doubt that the food shock has become a threat to social stability in much of the Middle East and possibly Asia. Food prices make up 50pc of the inflation index in the Philippines, and 37pc in China. It is less clear what the commodity shock means for the richer Atlantic world.

The current situation is unprecedented since excess global liquidity is flowing to the overheating economies of China, India, Brazil and the emerging powers, while parts of the West remain stuck in a "liquidity trap" with sluggish growth.

It is hard for Western central banks to calibrate policy in this new world order since their economies are no longer the driving force in commodity markets, unlike the 1970s when it was their own excess stimulus that set off the commodity spiral.

Rising resource prices in today's radically changed circumstances act as a tithe on US and European consumers and industry that must be paid to Mid-East petro-powers or Russian metal barons. This can have a deflationary impact, implying that moves to counter the effect by raising rates would make matters worse.

Germany's booming export sector has helped revive the eurozone over recent months but the Bundesbank forecasts a sharp slowdown in German growth this year, while the IMF expects fiscal tightening to delay recovery in Spain, Greece, Portugal and Ireland until 2012.

Eurozone retail sales have fallen for two months in a row, dropping 0.6pc in December. "Risks to the economic outlook are still slightly tilted to the downside," said Mr Trichet.

Veteran ECB watchers cautioned against reading too much into Mr Trichet's apparent retreat on inflation. Ken Wattret from BNP Paribas said there was a coded warning in the ECB's statement about upward pressure on prices in the "earlier stages of the production process", a precursor to inflation.

The German-led hawks at the ECB have not capitulated yet.

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Flat-Earth European Central Bank misreads oil spike again, and kicks Spain in the teeth

Dr Weber could hardly have done more to fuel the raging flames of euroscepticism in Germany, where 189 professors have warned of "fatal consequences" if the EU crosses the Rubicon to a `transfer union’ of shared debt liabilities. The three Bundestag blocs in Angela Merkel's coalition have issued a paper virtually ordering her to resist demands for yet more bail-out concessions at this month’s EU summit.

So yes, the ECB has a credibility problem in Germany. Yet to raise rates into an oil shock – as it did July 2008 when the global system was already buckling – is the central banking cousin of Flat Earth belief.

This is not a repeat of 2008, of course, yet something is still deeply wrong. The M3 money supply contracted in January and December. It has been negative since August (from €9.52 trillion to €9.48 trillion), and so has narrow M1. Private credit is growing at just 2pc.

This is the same bank that sat on its hands through the torrid autumn of 2005, keeping real rates negative as M3 growth rose at 8pc (double the ECB’s reference rate of 4.5pc), and as the Irish/Club Med property bubbles spiralled out of control.

Germany needed rates below the Euroland equilibrium at that moment. This is dirty secret that almost everybody in the German policy debate now chooses to forget, or never acknowledged. The ECB discriminated against Club Med. I should have thought Spain could sue the bank for misconduct at the European Court over that breach of its mandate.

Spain is now being whacked again. One-year Euribor rates jumped 14 basis points to 1.92pc within hours after ECB chief Jean-Claude Trichet uttered the code words “strong vigilance”. As the ECB knows, this is the rate used to price most Spanish mortgages.

Homeowners due for rescheduling in March will take the hit immediately. Fresh waves will follow each month, with knock-on effects for banks and Cajas already grappling with record defaults. Fitch Ratings said on Friday that the financial system will need €38bn in fresh capital to right the ship.

The Spanish might justly feel aggrieved, and judging by the comment threads of the Madrid press – "Put Trichet on trial", "Leave the EU immediately", "Create a currency for the South" – a vocal minority of Spaniards are going through their moment of EMU Epiphany.

Spain is doing what is required: slashing its twin deficits; biting the bullet on the Cajas (unlike Germany with the Landesbanken); and boosting exports faster than France or Italy. But Spain's chances of pulling through without a blow-up are contingent on EU authorities not committing another of their serial stupidities.

It was Mrs Merkel's call for creditor haircuts in October that pulled the rug from under the Irish, and set off EMU's Autumn contagion. Now the ECB is tossing its own hand-grenade into the peripheral debt markets, and doing so before there is any grand deal by EU leaders on a viable EU rescue machinery.

A month ago Mr Trichet sought to dampen prospects of a rate rise, insisting that inflation was "contained". Since then there has been a Mid-East revolution, the loss of 1m barrels of day (bpd) of Libyan oil, and a $15 premium on Brent crude to reflect the risk of Saudi revolt? This is dramatic, but not in itself inflationary.

Oil supply shocks depress the rest of the economy. They drain demand, acting as a tax siphoned off to Mid-East rentiers or the Kremlin. Headline inflation rises, but it signals the opposite of what is happening below the water line.

The ECB seems caught in a 1970s time-warp, wedded to the fallacy that the Yom Kippur oil shock caused the Great Inflation. The actual cause was rampant growth of the broad money supply, US spending on the Vietnam War and the Great Society, and a near ubiquitous picture of over-stimulus and over-heating across the West. It was a demand story, not a supply shock. Chalk and cheese.

The West is not over-heating today, except perhaps Germany, and that may not last as China slows. The eurozone grew just 0.3pc in the fourth quarter of 2010. The UK contracted. The US labour participation rate has continued falling over the last year to 64.2pc, the lowest since 1984.

Yes, China, India, and Brazil are overheating, pushing up global crude, metal, and grain prices. China alone is adding 850,000 bpd of oil demand each year, eating deep into global spare capacity. This is indeed a commodity demand story for the BRICs, but it has the characteristics of a supply shock for the West. There is nothing the ECB can usefully do about this, and it is suicidal to try. It is the task of the People's Bank to curb China’s credit bubble.

Trichet invoked the ECB's shibboleth of "second round” inflation effects. This is a sick joke as Spain and Portugal cut public wages by 5pc, Italy imposes a pay-freeze, and Ireland cuts the minimum wage by 11pc.

What he really meant is that settlements in Germany are creeping up. The car workers union IG Metall has secured a pay deal of 3pc to 3.5pc. Higher pay in Germany is exactly what is needed to help narrow the North-South gap in competitiveness without forcing wage deflation on Club Med, and it is exactly what the EMU-lords refuse to countenance. So the whole Euroland system must have a 1930s deflation bias.

It is twelve years since the launch of EMU. There has been no meaningful convergence of the disparate economies since then. The one-size-fits-all monetary policy continues to cause havoc. All that changes with the evolving economic cycle is a rotation in the locus of stress, and a change in its features.

Meanwhile, everything is tilted to meet the German imperative, but not enough to satisfy Germany. Nobody is satisfied.

Membership of monetary union as currently constructed is like walking with a sharp stone in your shoe, forever. You can put up with it, or take the stone out.

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