Is the ECB preparing to raise interest rates?

 

Frankfurter Allgemeine has an article saying that Axel Weber, Bundesbank president, hinted at an ECB rate increase (yes, increase). The ECB was concerned about the rise in food prices, he said, and would have to evaluate whether the present monetary stance is consistent with price stability.

 

We thought this was quite an extraordinary claim, and we bothered to double-check Mr Weber’s speech yesterday, which he delivered at the British Chamber of Commerice in Frankfurt. It is quite an extraordinary speech, though one cannot take it to be a warning that interest rates are about to go up. Nevertheless, the speech shows very clearly how different the Bundesbank’s economic assessment is from the consensus in financial markets. These are, in short summary, the points Weber made:

 

The first is that the German corporate sector has very strong balance sheets, as a result of efforts to raise competitiveness. Second is that the external demand for German products comes primarily from the euro area (40%), which is not subject to exchange rate movements, and second from newly industrialised nations, which have not yet been affected by the US slowdown. Third, he said the risk of a credit crunch in Germany are fairly remote, even if the credit crisis itself were to deteriorate.

 

On inflation, he said a central bank should not fight first-round effects. But there is a serious second-round problem building up right now. This is what he had to say:

 

Given the costs of curbing such inflation dynamics once they have started, the stability-oriented Eurosystem has to fight the risk of broad-based second-round effects decisively and proactively. The recent rounds of wage settlement in the euro area have not contributed to curbing inflation pressures. On the contrary, recent wage dynamics in conjuncture with elevated and persistent energy and food price pressures have increased the risk of a prolonged period of intolerably high inflation.

 

So this is not exactly: we are going to raise rates next month. But what we can deduce is that this important member of the ECB’s governing council believes that the risks are tilted towards higher inflation than towards lower growth. If it was up to him, he would probably have raised rates some time ago. We believe that he will put his case in front of the ECB’s governing council. But the actual chances of an imminent rate rise are not high. That said, the probability of a rate cut are probably much lower than that of a rate rise. Eurointelligence will produce an ECB-Watch note on this issue this weekend.

 

There are also dissenters in the US. The WSJ economics blog as an interesting article on two Fed governors who believe that the Fed has gone to far.

 

 

High inflation is a problem for Cyprus

High inflation relative to other eurozone members is a key concern for Cyprus,  reports Kathemerini. Central bank governor Athanassios Orphanides said that inflation could harm economic competitiveness on the island if it continued to outpace the average of the eurozone. Cyprus, which adopted the euro on January 1, 2008, recorded a 4.4% inflation rate in March, compared to the eurozone's average of 3.6%.

 

 

Why raw material prices are rising

Frankfurter Allgemeine writes that the rise in food and other commodity prices is driven to a large part by financial investors, which have put $40bn into these markets during the first three months. Most of these flows went into raw materials. The underlying reason is the strong economic growth of many newly industrialised nations, who have produced excess demand for goods with supply constraints. Another reason is the production of ethanole and other biofuels.

 

James Hamilton at the Econbrowser blog investigated whether there was any specific reasons why the WTI oil price has risen to $115pb. He concluded that this was not the case. “The reason is that we're seeing similar increases since the start of the year in the price of virtually every storable commodity. The 12% increase in oil prices this year is in fact just the median for the group of 15 commodities graphed below. It seems to me we should be looking for a single explanation behind the common behavior of the group, rather than try to develop a separate theory for aluminum, barley, coffee, cocoa, copper, corn, cotton, gold, lead, oats, oil, silver, tin, and wheat.”

 

In other words, the single reason is not industry-specific, but macroeconomic.

 

 

Investment banks want CDS clearinghouse

The FT reports that Deutsche Bank and other investment banks are working to set up a clearing house for the Credit Default Swap markets to deal with the problem of counterparty risk. The CDS market, which has been run large as an over the counter business, is $62 trillion in size – probably the largest financial market in the world. Spearheading this operation is the Clearing Corporation, a group that is jointly owned by 11 leading banks, such as Deutsche Bank, Credit Suisse, Goldman Sachs and some other trading platform providers, the FT says. The proposals are extremely controversial within the industry, as it might eventually lead to more regulation in the CDS sector.

 

 

A coalition between the CDU and the Greens

The first coalition between the conservative CDU and the Green’s was yesterday agreed in Hamburg, which is both Germany’s largest city, and one of the country’s smallest federal states. It is the first step in a process that might open up the German political system, where party alliances have generally failed to transcend traditional boundaries. The story is the big news in all the German newspapers this morning. Green party officials caution that Hamburg is special and may not serve as a blueprint for Berlin. There is much that separates the Greens and the CDU, nuclear power among those issues.

 

 

Boeri on Berlusconi

Tito Boeri writes in Lavoce that Berlusconi’s alliance had a better understanding of the deep frustration felt in Italy’s large cities, which contributed to his decisive victory. The most important task to improve economic growth, and unlike his predecessor he has strong majority in both the House and the Senate, and excuse not to reform. Boeri highlights three priorities for the first year: Fiscal federalism – giving the regions more autonomy; a new electoral law; and resisting the temptation to go back on the progress by the Prodi administration on tax evasion.

 

 

Stephens on Berlusconi

Philip Stephens writes in his FT column that Italy must have sunk pretty deep to resort to Berlusconi after all that has happened in the past. He said the one thing that surely disqualifies him as a leader is his media ownership. Imaging Angela Merkel or Gordon Brown doubling up as media tycoons? He concludes with the statement that Berlusconi is the symptom not the solution to Italy’s ills.

 

 

 

Let Britain’s housing bubble burst

Martin Wolf writes in his FT column that the UK authorities should allow the UK housing bubble to burst, and not artificially prolong the misery. The UK not only has one of the most inflated housing markets in the world, but is also a society with a prevalent belief that a nation can get rich by selling each other houses at persistently inflating prices. Wolf is sympathetic to the idea that the BoE should be mortgage-backed securities, though with big haircuts, but he is firmly opposed to any notion of the government bailing out homeowners.

 

 

France needs strategic choices

Emmanuel Harle in Les Echos argues that France is lacking a clear reform strategy. Instead of a broad defined reform agenda that avoids all difficult choices France should prioritise its reform efforts. To unlock potential growth it should concentrate on sectors where France has a comparative advantage, implement a Small Business Act, provide financing for new technologies and attract long term investors. France also needs to solve the incoherence of its social security system, whose financing relies heavily on scarce labour and whose protection is corporatist in nature. France needs a government that is willing to take strategic choices instead of juggling with economic and social regulation.

 

 

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