Monetary policy: ECB turns off the tap

7 April 2011 – Presseurop Les Echos

“European Central Bank ready to raise interest rates in Europe,” headlinesLes Echoson a day when the ECB is expected to increase its official market rate from 1% to 1.25%.

“For the first time in close to three years, the cost of borrowing will increase in the Eurozone. An era has come to a close. After two years of exceptionally low rates, the Sages in Frankfurt have sent out a signal that it is time to get back to normal,” writes the Paris daily’s editor in chief François Vidal.

However, he wonders if we should welcome this return to monetary orthodoxy -

“The two economic hypotheses on which the ECB’s initiative is based are by no means incontrovertible. Firstly, the risk of a return to inflation, which is viewed as an absolute evil in Frankfurt, has not been clearly established. The upsurge in the cost of raw materials has resulted in price increases in western economies, but nowhere have we seen any second-tier effects — i.e. demands for pay rises — including in Germany. Secondly, and this is without a doubt the key point, it is far from certain that the Eurozone is sufficiently robust to cope with an increase in the price of the basic resource for banks, and the appreciation of the euro that this will engender. It follows that there is a significant risk that the cycle of rate increases, which is now being launched, will hinder economic recovery and add to the difficulties of the most fragile countries in the Eurozone: Greece, Ireland and, since yesterday and in particular, Portugal. So the ECB’s decision is in many ways a gamble.”

But in the meantime, one thing is certain, concludes Les Echos -

“In its bid to avoid the worst, the ECB may well have exceeded its mandate, but the period of monetary generosity has come to an end. It will now be up to Europe’s governments to ensure the stability of the Eurozone.”

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