As the hours wound down before the widely anticipated European Central Bank’s modest 25-basis point interest rate hike, a leading inflation dove had flown into the kind of frenzied fury rarely seen. Even as wearied investors were coping with the Bear’s having snared the Dow Jones Industrials in its razor sharp claws and inflation-squeezed consumers were battered by a fresh surge in the price of crude oil, one inflation dove, The Telegraph’s Ambrose Evans-Pritchard, was screeching horrific, 'the world is ending,' doom and gloom.

His column was entitled, “Will Trichet drive the world over a cliff?” In that piece, he wrote, “Sadly, we are witnessing the sort of strategic errors that turned the recession of 1930 into a global catastrophe.” He continued, “The European Central Bank is now hell-bent on a course of action that will have a knock-on effect across the world and risk a dangerous implosion of the credit system.” Afterward, he predicted, “Let me put it differently: there is a grave risk of social and political disorder "exploding" if the logic of his argument is followed to its grim conclusion, that is to say if the ECB charges ahead with a string of rate rises through the autumn after its near certain move to 4.25 per cent on Thursday.”

Later, he charged the ECB with having forced the U.S. Federal Reserve into a tighter monetary posture at a time when “it badly needs to cut rates—perhaps to 1 percent.” Completely ignoring the inflationary reality of the present macroeconomic environment, he even claimed, “We are now in the eye of the post-bubble, debt-deleveraging, deflation storm.”

Not content to argue merely on the merits of a position that has little if any, Mr. Evans-Pritchard even directed an ad hominem attack against Mr. Trichet. “…I might add that Bernanke is one of the greatest economists of our age,” he wrote. No problem there. Some view him more favorably than others. However, Mr. Evans-Pritchard didn’t stop there. He added, “Trichet studied political administration at ENA. He is a fine and honourable man, but he is a politican, not an economic historian.” In other words, Mr. Trichet is unqualified to lead a central bank.

Rather than turning personal against Mr. Trichet, Mr. Evans-Pritchard would do better to consult an economics dictionary. Deflation is a time of falling prices. Inflation is a time of rising prices.

The European Union’s Harmonized Index of Consumer Prices (HICP) shows rising prices. Moreover, the EU’s inflation rate is increasing.


Source: European Central Bank

Worse, such price hikes are spilling into the services industry now. In reality, one is witnessing the dissipation of deflationary housing bubbles in a larger, increasingly inflationary environment.

On Monday, Bank for International Settlements General Manager Malcolm D. Knight observed, “For several years, general price inflation had remained quiescent even though the prices of industrial raw materials and many other commodities were rising strongly. Furthermore, for some time now, world demand seems to have been close to a level that, relative to capacity, eventually produces inflation pressures.” With respect to the arguments peddled by the inflation doves that the current inflationary episode will merely disappear as quickly as it thrust itself onto the world stage with no effort at all by the world’s central banks to combat it, Knight explained, “At present, most forecasters think that the recent rise in headline inflation in industrial countries represents a temporary blip and that, based on current expectations of how monetary policy will react, inflation will fall back in 2009. But we cannot be entirely confident about this reassuring assessment. Forecasters did not expect the successive increases in commodity prices and so underpredicted the present level of headline inflation. And inflation expectations, particularly those indicated by consumer surveys, have edged up significantly in recent months."

In the end, despite the cacophony of the inflation doves notwithstanding—and those economic birds are far from peaceful when it comes to promoting monetary policy that is in harmony with economic realities—the ECB headed by Jean-Claude Trichet is taking a modest and prudent step to keep inflation expectations anchored, mitigate the risk of destructive second-order effects, and reaffirm the credibility of the ECB’s commitment to price stability. It is a modest investment in sustainable real economic growth.

All said, if the larger global economy eventually collapses into recession, the ECB’s 25-basis point hike almost certainly will not be the cause. It is simply too small a change to crash the world’s economies, some of which retain strong growth momentum. More than likely, if bad monetary policy is to blame, those central banks that preserved an overly accommodative stance and later had to tighten far more dramatically than would otherwise have been the case had inflation expectations not become unanchored will have precipitated such an outcome.

Originally Posted by Kayleigh Katz I stated my position, and I'm 100% sure I'm correct because I am me.

Just prior to the ECB's interest rate hike, Sweden's Riksbank raised its benchmark interest rate 25 basis points to 4.50%. That central bank issued a bluntly worded statement concerning its responsibility to combat inflation and hinted that additional rate hikes could be required this year.

"Inflation has risen substantially and is at its highest level since the mid-1990s. The main reason for the high inflation is that energy and food prices in the world market have increased so much. But increasingly high domestic resource utilisation in recent years has also contributed to rising inflation. At the same time, inflation expectations remain high," the central bank's statement on its decision explained.

"Monetary policy has the task of stabilising inflation," the Riksbank declared, while adding, "The substantial rises in food and oil prices risk leading to other prices rising too quickly. The Riksbank’s assessment is therefore that the repo rate needs to be raised now and on a couple of further occasions during the year to bring inflation back towards the target a couple of years ahead."

This morning, the ECB hiked its benchmark interest rate to 4.25%. Jean-Claude Trichet's statement explaining the decision was pretty much along the lines of what had been noted in the opening post in this thread. Furthermore, contrary to the doom-and-gloom pronouncements peddled by some inflation doves, Wall Street responded positively to the decision, as futures strengthened in pre-market trading immediately following the decision.

A quick look at what the statement said vs. what I had expected to see:

• The decision to raise the benchmark rate will help ensure that inflation expectations remain anchored.

Statement: "On the basis of our current assessment, the monetary policy stance following today's decision will contribute to achieving our objective [of price stability in the medium-term and keeping medium- and long-term inflation expectations firmly anchored]."

• The Harmonized Index of Consumer Prices (HICP) “has remained above 3% for the past eight months.”

Statement: "...annual HICP inflation has remained well above the level consistent with price stability since last autumn..."

• The HICP reached 4.0% in June 2008.

Statement: "...according to Eurostat's flash estimate--4.0% in June."

• The risks to price stability over the medium-term have continued to increase.

Statement: "...very vigorous money and credit growth and the absence thus far of significant constraints on bank loan supply in a context of ongoing financial market tensions confirm our assessment of upside risks to price stability over the medium term." and "Risks to price stability at the policy-relevant medium-term horizon remain clearly on the upside and have increased further over the past few months."

• Inflationary pressures have remained more persistent than previously expected.

Statement: "We are thus currently experiencing a protracted period of high annual rates of inflation, which is likely to be more persistent than anticipated some months ago."

• Higher than anticipated wage growth could emerge, increasing the risk of “second round effects.”

Statement: "There is also a very strong concern that price and wage setting behaviour could add to inflation pressures via broadly-based second round effects."

• Timely and firm action will help prevent “second-round effects” and reduce the risks to medium-term price stability.

Nothing explicit on this point. The idea that such action would be effective was implicit in the statement that, "today's decision will contribute to achieving our objective..."

• The ECB remains determined to ensure that medium- and long-term inflation expectations remain anchored.

Statement: "...it is our strong determination to keep medium- and long-term inflation expectations firmly anchored in line with price stability..."

• The ECB will continue to monitor developments.

Statement: "We will continue to monitor very closely all developments over the period ahead."

Also, the ECB urged private and public sector participants in wage-related negotiations to avoid nominal wage schemes that could trigger a wage-price spiral.

Finally, the ECB did not rule out or indicate future interest rate hikes. Instead, in the press conference that followed, Jean-Claude Trichet stated, "Starting from here, I have no bias."

All in all, the ECB's decision, policy statement, and Jean-Claude Trichet's remarks at the press conference were in line with what I thought was likely. I believe the decision is a sound one. Moreover, it was a decision that was well-received in the financial markets. Despite a somewhat weaker employment report than had been expected in the consensus estimate by economists, the Dow Jones Industrials were up more than 90 points just after 11:20 am.

Later developments could still impact the course of trading. But what is relevant is that the ECB's decision did not bring about the adverse impact some of those who opposed the rate hike predicted. Rather, contrary to their expectations, the financial markets liked the move.