Thursday, July 3, 2008

The ECB raised rates and the market cheered

The ECB increased its key lending rate by 25 bp to 4.25 percent. Jean-Claude Trichet in his introductory statement and the ensuing press conference made clear that the Central bank is committed to price stability. The move today clearly demonstrates that the governing council is not shying away from unpopular decisions according to its mandate and its guaranteed independence. The euro was bid after the press conference mainly because Trichet refused to precommit to further rate hikes. We consider this as extremely clever since uncertainty in the economy prevail and all options for the ECB remain on the table. The market reacted very favorably as seen in the charts below.

What a difference sound and consistent policy makes!

Below is an excerpt from the statement. The underlined sentences are identical (at least very similar) to last month's statement, bold sentences represent new additions, and sentences in parenthesis are missing in this month statement. The most important difference in our opinion is the omittance of "heightened alertness" and "price stability is of the essence", which obviously led market participants to believe that the ECB will refrain from further rate increases. We think this is premature in the light of Trichet's refusal to precommit.

Introductory Statement July 2008
To sum up, a cross-check of the outcome of the economic analysis with that of the monetary analysis clearly confirms the assessment of increasing upside risks to price stability over the medium term, in a context of very vigorous money and credit growth and the absence thus far of significant constraints on bank loan supply. At the same time, the economic fundamentals of the euro area are sound, and incoming macroeconomic data continue to point to moderate ongoing real GDP growth when the high volatility of growth rates in the first half of this year is taken properly into account. Against this background and in full accordance with our mandate, it is imperative that we prevent broadly based second-round effects and counteract the increasing risks to price stability. We emphasise that maintaining price stability in the medium term is our primary objective and that it is our strong determination to keep medium and long-term inflation expectations firmly anchored in line with price stability, thereby preserving purchasing power in the medium term and supporting sustainable growth and employment in the euro area. (Against this background, the Governing Council is monitoring very closely all developments. It is in a state of heightened alertness.) On the basis of our current assessment, the monetary policy stance following today’s decision will contribute to achieving our objective. We will continue to monitor very closely all developments over the period ahead. (Securing a firm anchoring of medium and long-term inflation expectations in line with price stability is of the essence.)

The full text of the statement can be found here.

click for video, Trichet Q&A

source: Introductory statement
Jean-Claude Trichet, President of the ECB, Lucas Papademos, Vice President of the ECB Frankfurt am Main, 7 July 2008

video: Question and answer session

ECB Introductory Statement, July 3, 2008

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