March 31, 2011 / 1:24 PM / 9 years ago

ECB FOCUS-Europe rates to lead U.S. as global power shifts

* ECB hiking before Fed would be new in a tightening cycle

* Shows Asia’s increased influence on euro zone

* Fed likely to narrow rate gap with ECB later

By Paul Carrel

FRANKFURT, March 31 (Reuters) - After following the Federal Reserve’s lead for over a decade, the European Central Bank is poised to launch a series of interest rate hikes before the U.S. central bank for the first time in the ECB’s history.

The change from the traditional pattern reflects the ECB’s greater preoccupation with inflation pressures, as well as its higher level of discomfort with the emergency bond-buying programmes run by central banks.

But the “decoupling” of ECB and Fed policies is also the result of an historic shift in the global economy: the increased influence that Asia, rather than the United States, is having on the euro zone’s economy.

“I think we are in a new world where global interest rate cycles are not initiated by the Fed,” said Jens Sondergaard, senior European economist at Nomura.

“There has been a lot of import price inflation pushing up euro area inflation...and a lot of this is related to above-trend growth in Asia.”

Sondergaard said monetary policy tightening already initiated by central banks in emerging markets, including China, was increasingly important for the rest of the world. China has raised official interest rates three times and commercial banks’ reserve requirements five times since October.

ECB Executive Board member Lorenzo Bini Smaghi cited growth in emerging economies as well as higher commodity prices when he said in mid-March that inflation risks had increased.

He explicitly warned that the euro zone risked importing inflation from China, where consumer prices have been rising at an annual rate of around 5 percent. [ID:nLDE72D2I7]


For a graphic on Fed vs Bundesbank/ECB interest rates, click:

For a graphic on Bundesbank/ECB and inflation, click:



The ECB’s Governing Council holds a policy meeting next Thursday and its members have been out in force signalling they will raise rates, with council member Jozef Makuch saying this week that a rise is “highly likely”. [ID:nLDE72S1P7]

An ECB rate hike would be the first since July 2008, when the ECB raised rates in response to oil price-fuelled inflation just ahead of the Lehman Brothers collapse which tipped the global financial system into full-blown crisis.

The ECB has been widely criticised for the 2008 rise but the bank’s president, Jean-Claude Trichet, deliberately referred to it in January as a sign of his determination to fight inflation. [ID:nLDE70C26B]

“They almost wear that as a badge of honour,” said RBS economist Nick Matthews.

In its last full tightening cycle, begun in December 2005, the ECB lagged the Fed in raising rates by 1-1/2 years. Its cycle kicked in just as a recovery in Germany — the euro zone’s largest economy — gained traction after a period of stagnation.

Now Germany is booming, buoyed by strength in its exporters, whose business has been boosted by dynamic growth in China.

Consumer price inflation in the euro zone was 2.6 percent in March, up from 2.4 percent in February and well above the ECB’s target of close to but below 2 percent. In the United States, the rate was 2.1 percent for February. [ID:nLDE72U14W] [ID:nN16149631]


Historically the Fed, which does not have a formal, explicit inflation target, has been somewhat happier to accept higher inflation than the 12-year-old ECB and Germany’s Bundesbank before it.

Although the euro zone and the United States face similar external inflation pressures, their central banks take a different view of their economies. The Fed’s mandate requires it to promote full employment in addition to keeping inflation in check; the ECB’s focus is delivering price stability — a reflection of its mandate, but also the legacy of the hawkish Bundesbank, which the ECB carries in its DNA.

This ideological difference has existed throughout the ECB’s life, but the new global environment of high commodity prices and Asia-led economic growth may be causing the gap to widen.

This is suggested by the central banks’ approach to the bond-buying schemes they adopted to fight financial crises. The ECB has “sterilised” its purchases by taking an equal amount of money in deposits, so the effect on the money supply is neutral, and many of its policymakers are uncomfortable with its scheme.

While some Fed policymakers have recently suggested ending their scheme early, the U.S. central bank has not sterilised purchases and overall has appeared more comfortable with them. This month the Fed reiterated a pledge to keep interest rates, currently near zero, at very low levels for an extended period.

“They are happy enough to keep rates low and they are not particularly agitated about the other roles they have taken on,” Vanessa Rossi, senior research fellow at London-based think tank Chatham House, said of the Fed.

“They are not pressing to quickly end these roles, whereas in Europe it’s clear that the ECB has been uncomfortable with unconventional policies and would like to get back to what it considers normal.”

The divergence between the ECB and the Fed has produced situations where the ECB seems to be publicly criticising the U.S. central bank. In January Trichet declared central banks should not focus on core inflation, which excludes food and energy prices; the Fed has long looked at core inflation.


A Reuters poll of analysts published on Wednesday suggested the ECB will raise rates when it meets next week and is set to follow with a couple more hikes by the end of the year. By contrast, the Fed is not expected to hike until 2012. [ECB/INT]

Many analysts expect it to close the interest rate gap with the ECB when it eventually does start hiking, since weakness in indebted economies on the periphery of the euro zone may restrict the ECB’s room to tighten policy.

“Can you have a protracted decoupling of Fed and ECB policies?” asked Matthews. “That’s probably unlikely.”

Nevertheless, the new balance in the global economy probably means that in future, it will not be possible to assume the ECB will follow the Fed in changing course on monetary policy. The eventual recovery of peripheral euro zone economies from their debt crises, perhaps in a few years, may reinforce this change. (Editing by Andrew Torchia)

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