Weber Says Market Underestimating Inflation Concerns
Written on February 15, 2008
European Central Bank council member Axel Weber said investor bets that the ECB will cut interest rates are misguided because they overlook policy makers' determination to prevent an inflation spiral.
“Current interest-rate expectations on financial markets, at least for a stability oriented central banker, do not reflect an appropriate assessment of inflation risks,'' Weber said in the text of a speech today in Siegen, Germany.
Investors increased expectations for the ECB to follow its U.S. and U.K. counterparts in cutting interest rates after ECB President Jean-Claude Trichet last week said uncertainty surrounding the euro-area's growth outlook is “unusually high.'' The bank on Feb. 7 left the key rate at a six-year high of 4 percent, shelving discussion of a rate increase.
“These are undeniably hawkish comments, with a specific reference to market expectations being inappropriate to a stability-oriented central banker,'' said Ken Wattret, chief euro- area economist at BNP Paribas in London. “It would seem that others on the governing council increasingly appear not to share this view.''
While Weber acknowledged that “the risks to growth point downward,'' policy makers “continue to be more concerned'' about inflation. Euro-area inflation was 3.2 percent in January, the fastest in 14 years and above the 2 percent ECB ceiling.
Slowing Growth
Risks to price stability are “clearly pointing upward,'' said Weber, who is also head of Germany's Bundesbank. “That's why it's even more important to nip in the bud any chance that second- round effects should delay the decline in inflation rates that are currently far too high.''
Some ECB council members have indicated they count on slowing economic growth to push down inflation. Belgium's Guy Quaden said this week the “deceleration'' of growth “could be stronger with possible effects on the inflation rate over the medium term.''
The euro-area's economic expansion slowed to 0.4 percent in the fourth quarter from 0.8 percent in the previous three months as inflation crimped household spending and the euro's strength made exports less competitive.
Investors still expect the ECB to pare its benchmark once or twice this year, futures trading shows. The yield on contracts maturing in December was at 3.50 percent today. It was as high as 4.36 percent on Dec. 27, and has averaged 31 basis points more than the bank's key rate for the past five years.
`Too Aggressive'
Weber's comments suggest “markets are too aggressive in pricing in near-term rate cuts,'' said Dario Perkins, an economist at ABN Amro Holding NV in London. “Trichet tried to provide a fairly sophisticated, neutral bias at this month's press conference cash advance. It might have been too sophisticated for some.''
In the U.S., the Federal Reserve has pared its main rate to 3 percent from 5.5 percent since September to keep the world's largest economy from sliding into a recession. The Bank of England last week cut rates for the second time in three months, taking its benchmark to 5.25 percent.
Commerzbank AG, Germany's second-largest bank, said today that fourth-quarter profit fell 44 percent on writedowns related to U.S. subprime assets. The worst U.S. housing market in a quarter century has led to more than $145 billion in writedowns and loan losses at the world's largest financial institutions.
Weber said it “can't be ruled out'' that recent financial market turmoil will drag down the U.S. economy. “For Germany and the euro-area the fallout should be limited.''
`Trade-Off' Situation
Professional forecasters lowered their growth estimate to 1.8 percent this year, down from 2.1 percent in November, the ECB monthly report showed today. At the same time, the economists polled by the ECB increased their inflation forecast by half a percentage point to 2.5 percent this year.
The survey published today “shows a gradual increase in long-term inflation expectations over the past year,'' Weber said. “The probability that the inflation rate will average 2 percent or above in five years time has increased from 44 percent at the beginning of last year, to 49 percent'' early 2008.
With euro-region unemployment at a record-low of 7.2 percent, the ECB is concerned about companies raising prices and wages to compensate higher costs. Weber today called for “decisive'' action against so-called second-round effects leading to more persistent inflation across the economy of the 15 euro nations.
In Germany, Europe's largest economy, public-sector workers want the biggest pay raise in 16 years. Ver.di, Germany's second- biggest labor union, is seeking 8 percent more pay for about 1.3 million workers on federal and local government payrolls.
“On one hand, the inflation development suggests raising interest rates,'' Weber said, when commenting on what he called a “trade-off-situation'' between faster inflation and slowing growth. “On the other hand, higher interest rates could also increase economic risks.'' The ECB has to “give priority to price stability,'' according to its mandate, Weber said.
The ECB is scheduled to hold its next monetary policy assessment on March 6 in Frankfurt.