The ECB Will Continue to Hold Despite Overshooting Policy Targets

The next council meeting of the European Central Bank (ECB) on April 10 will most likely decide to keep the main refinancing rate steady at 4%. Taking it from ECB president Jean-Claude Trichet's hearing at the European Parliament on Wednesday, markets can expect another statement peppered with his favorite phrases on "vigilance," but not a rate cut as a sign the ECB is really serious in combatting inflation and excessive money supply growth.

Inflation has risen to a record annual rate of 3.3% in February, Eurostat reported earlier this month. The acceleration in consumer prices now exceeds the ECB's target of 2% by 65%.

Money supply M3 growth has at least stabilized, but at an annual rate of 11.5% still overshoots the ECB's target rate of 4.5% by 155%. MSM have ignored the explosive trend in money supply for years by now.

Trichet had reiterated on Wednesday that the ECB's sole function is to keep inflation at bay, indirectly ruling out bailouts of ailing Eurozone banks which he called financially stable but threatened from a shrinking of their revenue base.

Trichet also upheld his view that medium term inflationary pressures would subside by 2009. I wonder where he takes his optimism from when Eurozone producer prices accelerated to 4.9% (4.4%) p.a. in January. As this number was most heavily influenced by surging energy prices I cannot see any improvement in the light of triple digit crude oil prices.

The ECB certainly is in a tricky situation. The surging Euro may result in a further widening of the Eurozone trade deficit, which in January rose from €7.2 billion to €10.7 billion YOY. Including the non-Euro members the EU trade deficit almost doubled to €30.7 billion MOM in January.

A rise in Eurozone interest rates could lead to massive build-ups in the dollar-Euro carry trade where investors borrow in dollars and invest proceeds in higher yielding Euro debt paper. The ECB wants to avoid further speculative inflows that would put more upward pressure on the Euro, which will celebrate its 10th anniversary next year - if all goes well.

While the ECB will hold the official rate steady, banks are scrambling for refinancing. Wednesday's €50 billion repo saw the average rate shoot up to 4.53% from 4.4% a fortnight earlier.

As usual, many questions will remain open even after the press conference after the council meeting.

Participating journalists will probably remain ignorant about the highly worrying trend in M3 growth as they have done in the past 4 years.

The other open question concerns #9 on the asset side of the ECB's balance sheet, so called other assets. This position is a hide-all for the ECB and nobody has ever asked what kind of securities supposedly valued at €333 billion are in there. According to the ECB,

the position other assets is a collective item including, in particular, items in the course of settlement (settlement account balances, for example the float of cheques in collection), coins of euro area Member States and other financial assets (e.g. equity shares, participating interests, investment portfolios related to central banks' own funds, pension funds and severance schemes or securities held due to statutory requirements). This item also contains tangible and intangible fixed assets, revaluation differences on off-balance-sheet instruments as well as accruals and deferred expenditure.

IMHO this position can absorb any crap paper the ECB decides to buy for whatever reasons. Find the explanation of all positions here.

DB Research just issued a paper that has more interesting background on ECB policy and stresses the point that there will be no bailouts as the only mandate of the ECB is to fight inflation.

One Eurozone Central Bank Appears To Have Massive Problems

As the ECB has now advised for the third week in a row that its weekly financial statement is inaccurate due to one Eurozone central bank having problems to deliver its data, I will wear my crash helmet 24/7. According to the ECB,

The exceptional circumstances in one Eurosystem central bank, which prevented that central bank from producing its balance sheet as at 7 March and 14 March 2008, have continued and have also prevented the production of a balance sheet as at 21 March 2008. Consequently this week’s Eurosystem consolidated financial statement reflects the latest available balance sheet information provided by the Eurosystem central bank in question, namely its financial statement as at 29 February 2008.

Will this become another example of denial of reality until it cannot be hidden anymore? Get prepared for the worst.

Comments

[whidbey]

Hard to believe that EU banks have avoided the toxic trash asset class, the problem is: what would the ECB do given its view of its mandate? Fight inflation? What about fighting deflation? Possibly we worry too much, but if your house is on fire one tends to be sensitive to smoke from across the street. I think another leg down is probable.

[GKM]

If the UK is on the precipice of a housing meltdown, it would seem unlikely that EU banks have dodged the double bullet of UK and US toxic paper.