Late on Tuesday Eurostat published its flash estimate for Euro zone inflation in December 2009. It showed the Monetary Union Index of Consumer Prices have risen from an annual rate of 0.5% in November 2009 to an annual rate of 0.9% in December. To put this into context the rate was negative as recently as June 2009.Therefore annual inflation for 2009 has averaged around 0.3% in the Euro zone.This compares with the European Central Banks (ECB) target ceiling of 2%. Although Eurostat does not publish a detailed breakdown at this stage it seems likely that oil prices are the main cause of the rise as they were only $35/40 a barrel a year ago. Yes I did double- check that oil price if you are wondering as it surprised me too.
Implications for the ECB
If one projects the trends forward then it would appear that the ECB is under no pressure from its inflation rate to change its monetary policy. So it is quite possible that it will be able to maintain its 1% interest rate for some time yet. It would appear that inflation and inflationary expectations have remained much more stable in the Euro zone that they have in the UK or US. This is a policy success for the ECB in my view. It adds more weight to the argument that the Quantitative Easing (QE) programmes instituted in both the US and UK have certainly managed to raise inflationary expectations and in the UK’s case perhaps raise inflation itself.
At this moment the UK Consumer Price Index is only 0.1% below its target of 2%. The depreciating sterling exchange rate has also contributed to its inflation problems but not all of the rise (and the likely rise to come) has been caused by it in my view. Also there are second order effects to be accounted for as in my opinion some of the fall in the UK exchange rate was caused by QE being viewed as certainly risky and potentially inflationary. Econometrics is never simple is invariably complex and is sometimes unfathomable as so many variables influence each other.
When the “credit-crunch” began it was considered to be a disadvantage for the ECB that its ability to indulge in unconventional monetary policies was limited compared with the Federal Reserve and the Bank of England. The reason for this was of course that Europe has 16 different governments with different fiscal policies whereas both the UK and US have national governments. Therefore polices such as QE were not feasible for the ECB. However as the Euro zone has returned to growth earlier than the UK and its inflation is currently looking more under control it is now looking possible that conventional monetary policy such as reducing interest rates and supplying short-term liquidity to money markets is outperforming unconventional monetary policy. Of course the effect of QE may be lagged but does this mean that it will work at the wrong time? Those who follow Japan’s experience may question what benefits it brings at all.
Was the ECB lucky that QE was not a feasible policy option?
Only time will fully tell but the fact that the question even occurs to me is an answer in itself.