European Central Bank council member Yves Mersch said officials may toughen their language on inflation next week, indicating a readiness to raise interest rates in coming months.
“I would not be surprised at most colleagues concluding that we have upside risks to price stability,” Mersch said in an interview in Luxembourg yesterday. With the economy strengthening and inflation in breach of the ECB’s 2 percent limit, policy makers will “inevitably” have to “rebalance our monetary policy stance,” Mersch said, without giving a timeframe.
The ECB, which has kept its benchmark interest rate at a record low of 1 percent for almost two years, is growing more concerned that soaring energy and food prices will drive up wages and entrench faster inflation. At the same time, raising borrowing costs too soon could exacerbate Europe’s sovereign debt crisis by increasing pressure on stressed banking systems in countries such as Greece and Ireland.
The euro rose more than a cent to as high as $1.3682 after Mersch’s comments were published. Euribor futures extended a decline, with the implied yield on the contract expiring in December increasing seven basis points to 1.97 percent, as traders added to bets on higher ECB rates. German two-year government notes fell, sending the yield up six basis points to 1.44 percent.
September Increase?
So far, ECB President Jean-Claude Trichet has said risks to the inflation outlook are “broadly balanced,” though they “could move to the upside.” The ECB will raise its key rate by a quarter-point to 1.25 percent in September, Eonia forward contracts show.
“There is a risk now that the ECB may raise before September,” said Nick Kounis, chief European economist at ABN Amro in Amsterdam. “While Mersch is a traditional inflation fighter, even the normally dovish members are sounding hawkish.”
ECB council member Athanasios Orphanides told Dow Jones in an interview published yesterday that the bank “must be ready to act as appropriate to safeguard price stability.” Nout Wellink of the Netherlands said in an interview with the Wall Street Journal published today that the ECB’s key rate may “distort the economic and financial process” if left at 1 percent too long.
Inflation Projections
Executive Board member Juergen Stark said last night that the ECB is “prepared to act decisively and immediately if needed” to maintain price stability, and fellow board member Lorenzo Bini Smaghi said the bank may need to reassess its policy stance.
At the next policy meeting on March 3, the ECB will publish its latest economic projections. Mersch said he expects ECB economists to lift their 2011 inflation forecast to more than 2 percent from 1.8 percent predicted in December. Inflation accelerated to 2.4 percent last month.
“Now the question is what about 2012, will this be a temporary hump or will this translate into a plateau?” Mersch said. “This very much depends on second-round effects.”
Crude oil prices have surged 27 percent over the past six months, pushing up import prices and adding to pressure on labor unions to secure bigger pay increases for workers.
Economic Outlook
Faster growth in countries like Germany, Europe’s largest economy, may also fan inflation. German business confidence surged to a record high this month and expansion in the euro region’s service and manufacturing industries accelerated to the fastest pace in more than four years.
Mersch said policy makers may next week change their view that risks to the economic outlook are “slightly tilted to the downside.”
Mersch, 61, has been touted by some economists as a possible successor to Trichet when his eight-year term ends on Oct. 31. Asked if he’s interested in the job, the Luxembourg central banker declined to comment, saying it’s a question for “the leaders who will make this decision.”
Wellink today declared his interest in the position, telling an audience at the University of Amsterdam that if asked, he would “think about it seriously.” Other possible candidates include Italy’s Mario Draghi and Finland’s Erkki Liikanen.
Before the Fed
Mersch said the ECB is not concerned that raising borrowing costs before the Federal Reserve could drive up the euro’s exchange rate. “We’ll raise rates when we find the situation warrants it, not on the time axis that belongs to market analysts,” he said. “We have no exchange-rate objective.”
The ECB is “fully aware that excessively low interest rates create distortions in the economy,” Mersch said.
Still, he warned against “moving into a posture of over- confidence by trying to make forward commitments in a period where uncertainty is still quite high.”
The ECB has twice been forced to abandon its exit from emergency measures designed to help banks through the financial and debt crises.
Mersch said officials are looking at resuming a “gradual” exit. One step may be to charge banks more when they borrow excessively from the ECB in an effort to wean them off the funds. Some banks have become too reliant on ECB cash after the central bank made unlimited amounts available at its benchmark rate to ease a liquidity squeeze.
“I cannot confirm that the solution that will be announced is a solution that is only a solution where price is affected,” Mersch said. “There can also be solutions where you act on the quantity. I can tell you that we are very far in our decision- making process.”
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