FIrst hawkish sounds from Frankfurt

The ECB just left interest rates unchanged. While Trichet was rather close-lipped on the sovereign debt crisis and possible new measures by EU leaders in the coming weeks, he sent a slightly more hawkish message on monetary policy. According to the ECB, interest rates remain “still” appropriate, suggesting that this is not self-evident anymore. Inflation will again be top of mind at the ECB in 2011.

The ECB’s macro-economic assessment has taken a shift towards more hawkishness. On growth, this shift was rather marginal and in the eyes of the Governing Council risks to growth are still “slightly” tilted to the downside. On inflation, however, the ECB sent a stronger message of hawkishness. The ECB now sees evidence of “short-term upward pressure on overall inflation, stemming largely from global commodity prices”. The phrase “while this has not so far affected our assessment that price developments will remain in line with price stability over the policy-relevant horizon, very close monitoring of price development is warranted” sends a clear signal that the ECB stands ready to scotch any pass-through of energy and food prices into the economy.

Trichet is not getting tired of repeating and stressing the ECB’s inflation track record. Since the start of the monetary union, average inflation was 1.97%, neatly in line with the ECB definition of price stability. This track record could keel over this year. Food and energy prices are not likely to drop significantly any time soon and if the impact of higher commodity prices in 2007/2008 is of any guidance, headline inflation could easily remain above 2% throughout the year. If headline inflation was to remain at its December-level throughout 2011, Trichet’s most favourite inflation track record would increase to 1.99%.

At the current juncture, a rate increase would still do more harm than good. The Eurozone periphery is economically still too weak to stomach higher rates, the sovereign debt crisis is far from over and a rate hike would not stop commodity prices from increasing. However, for the Eurozone as a whole, the monetary stance is increasingly becoming loose. Up to now, the ECB has been the first line of defense – the fire brigade – of the Eurozone’s sovereign debt crisis management. Low inflation gave the ECB ample room to implement non-standard measures. Today’s meeting clearly indicates that the ECB is reprioritizing and that inflation developments will be top of mind throughout 2011.

It looks as if we do not need to wait for Axel Weber to become ECB president to see a hawkish ECB. The ECB headed by Jean-Claude Trichet can also send hawkish statements. Of course, all will depend on commodity prices and their pass-through but with today’s meeting chances of an earlier rather than later rate hike have increased.