It was déjà vu all over again today as Trichet shot a strong-dollar-accord notion in the head and drove a stake through the heart of coordinated global monetary policy. In May Trichet was ardent about risks to inflation and confident on economic fundamentals (growth) just days after US Treasury Secretary Paulson tried to let markets know that the US Treasury really does want a strong dollar after all. Euro/dollar decline reversed. It was déjà vu all over again today as Trichet shot a strong-dollar-accord notion in the head and drove a stake through the heart of coordinated global monetary policy. In May Trichet was ardent about risks to inflation and confident on economic fundamentals (growth) just days after US Treasury Secretary Paulson tried to let markets know that the US Treasury really does want a strong dollar after all. Euro/dollar decline reversed. Monday and Tuesday in an unprecedented fashion Paulson and Bernanke tag teamed to talk the dollar higher fanning speculation that something far more serious was underway to at the very least keep the dollar from depreciating, though the apparent emphasis was higher would be better than stable. Trichet and the ECB (let’s not forget that this is an unwieldy group of central bankers and not simply his show) needed to check inflation concerns, highlight risks to growth and reiterate that markets should pay attention to what Paulson and Bernanke said about the dollar this week to be Stanley Laurel to the Fed’s Oliver Hardy. Instead Trichet was the anti-MacGyver…not the fixit man but the break it man.
If price stability is the altar of the ECB’s cathedral, then growth, coordinated monetary policy and a stronger dollar were sacrificed today on that very altar (again).
We learned today that the ECB sees risks to price stability rising since the last meeting, it may require a policy tightening and the staff elevated its inflation forecast for 2008 to 3.2-3.6% from 2.6-3.2% in March (and raised the 2009 HICP forecast range from March estimate). Moreover, Trichet said that inflation was persistent and would not likely come down until 2009 and would hold above 3% for the period ahead. Trichet’s press briefing was more a defense over why the Bank failed to hike today which prompted the disclosure that the Bank was split over raising rates today, signaling a rate hike in July and no change in message on rates. And pressed by the press Trichet said a modest rate hike may be required ahead – presumably July and something less than 25 bps – 17.5 bps seems reasonable.
First let’s look at growth. Trichet was not only confident about growth and real economic fundamentals (wonder if PIGS agree – Portugal, Italy, Greece and Spain – PIGS is from FX Concepts), but the ECB staff raised the 2008 forecast range to 1.5-2.1% from 1.3-2.1% in March (though lowered the 2009 GDP estimate from March). Get the impression the ECB thinks growth needs to be slower to check inflation or that because business conditions are so strong wage negotiations favor workers (okay index wage hikes make sense as a concern, but how much of the labor force in the 15 member EZ is working in index-linked wage world?).
Growth in the EZ is not likely to hold up ahead with the US economy slowing…and slowing more broadly – not just housing, banking and autos but airlines, retail, restaurants and lodging are all catching up. And US state and local governments are cutting employees rapidly. China importing capital equipment from Germany to manufacture furniture for the US market is nothing I would bank on. Also the edges of the Euro Zone growth story are rapidly fraying – Spain and increasingly Italy are suffering weakness on multiple fronts…suspect Greece, Portugal and Ireland are not far behind.
And what does the current brand of inflation do mainly? Well given it is commodity led it erodes real income for consumers and earnings for firms. These are growth negatives unless you can export your way around a domestic economic slowdown.
But apart from ignoring risks to growth, Trichet also put a stake through the heart of coordinated monetary policy. I think we live in a highly globalized economy where the US economy is the nucleus. The Fed is the central bank to the world economy. And the rest of the world’s central banks are in effect the equivalent of the national central banks in EMU. The Fed has made it clear that rates are on hold ahead – no mas on further policy accommodation – and if anything has called for a higher dollar to address inflation pressures from commodity prices and inflation expectations while interest rate hikes are not advisable in light of weakened US banking system and headwind for growth. To date the Fed has not just been providing a lift to US growth but to global growth – keep the US consumption engine humming keep global economic activity humming. Bernanke’s speech Tuesday was also a call to the rest of the world’s central banks to think about pulling its share of the accommodation burden now that the Fed has paused. Trichet and the ECB said no thank you and put ECB’s 3.6% HICP in May above larger global economic best interest. In time it may well be the breakdown in global monetary policy coordination that causes a serious global recession. After today I have less confidence that the ECB can play Stan to the Fed’s Ollie. Furthermore one has to ask how much longer the EZ (EMU) will run without internal rebellion. My bet is by the fall Italy under Berlusconi will be threatening to leave EMU unless the ECB addresses growth and the euro.
Finally Trichet has been an advocate of a lower euro and higher dollar (and yen) for some time. He has no business talking the euro down period…not when the ECB is on the verge of a rate hike in the face of the greatest potential economic downturn in 70 years. With inflation blurring ECB vision one has to ask seriously whether 1.60 is better for inflation than 1.50. Maybe 1.70 is best now that Trichet has launched oil back above $130.
I have a problem no doubt. My early market seasoning happened when currency accords and intervention were unfolding and central banks were moving in a coordinated fashion to address larger risks to the global economy than national self interest. I suffer from nostalgia-bias…it won’t ever be the same despite the increased interdependence of the global economy. Moreover, the notion of the US as a leader in global anything has been grossly devalued…some of it for political reasons and some for economic…emerging world preeminence and a good economic run for the money to date from the Euro Zone.
So today was another one of those lessons that the past is not a reliable guide to the future. In this every man for himself world, the downside risks are unthinkable and Trichet and ECB showed today that despite an unprecedented need for a global monetary policy response (not a global liquidity response – this has worked well) a simple rule – inflation target – trumps everything.
Here is my forecast…the euro in time gets punished for the ECB’s single-mindedness…elevating the risk of a EZ and global recession at a time when accommodation is called for with the Fed done. Dare I say that the 10 year anniversary of the ECB may be the high water mark for EMU…the very premise of EMU could see a serious challenge internally as weaklings in the EZ have diverging interests and the global economy shuts off external growth all the while the monetary policy makers in Europe worship daily at the inflation altar adorned with a huge graphic of <2%.