Trichet Puts Inflation Back on ECB Agenda as Leaders Plot Debt Crisis Fix

Jean-Claude Trichet has put inflation fighting back on the European Central Bank’s agenda in the middle of a sovereign debt crisis.

As governments struggle to contain a loss of investor confidence that’s pushed market borrowing costs in debt-strapped nations to euro-era highs, the ECB President yesterday signaled he won’t hesitate to raise interest rates if needed to keep inflation in check.

“Up to now, the ECB has been the first line of defense, the fire brigade of crisis management,” said Carsten Brzeski, an economist at ING Group NV in Brussels. “Trichet has clearly indicated that the ECB is reprioritizing, and that inflation developments will be the top priority throughout 2011.”

The shift in emphasis from Trichet has already prompted some economists to bring forward forecasts for the ECB’s first rate increase and raises the likelihood that it could act before the Federal Reserve. It also adds to pressure on politicians to agree on an improved rescue package for the euro area.

“I don’t think it’s a bluff,” said Peter Westaway, chief European economist at Nomura International Plc in London. “Trichet could be preparing the ground for a rate hike by the summer.”

The euro rose more than a cent after Trichet’s remarks and strengthened to $1.3441 at 9:30 a.m. in Frankfurt today, three cents higher than the same time yesterday. German bonds declined, pushing the two-year yield up 15 basis points to 1.14 percent, a two-month high.

Unprecedented Steps

Trichet, whose eight-year term ends on Oct. 31, has been forced to take unprecedented steps to buy time for the euro as governments struggle to agree on how best to shore up confidence in the 17-member monetary union.

The ECB’s decision to buy government bonds split its Governing Council, and some policy makers have warned that price stability, the bank’s primary goal, could be compromised if emergency measures are left in place too long.

The ECB has repeatedly been forced to delay the withdrawal of unlimited liquidity for banks as the crisis intensified.

“It sounds pretty much as though the ECB has decided to go back to the basics of monetary policy,” said Natacha Valla, a former ECB economist now at Goldman Sachs Group Inc. in Paris.

Policy makers yesterday kept their benchmark interest rate at a record low of 1 percent. While describing the level as “appropriate” to indicate an imminent change is unlikely, Trichet said the bank has “never pre-committed not to move interest rates.”

Inflation Pressure

There is “short-term upward pressure” on inflation and though risks to the medium-term outlook for price developments are still broadly balanced, they “could move to the upside,” he said.

Inflation accelerated to 2.2 percent last month, breaching the ECB’s 2 percent limit for the first time in more than two years. Trichet said it may quicken further before moderating toward the end of the year.

Citigroup Inc. revised its forecast for the ECB’s first rate increase to the second half of this year from the first quarter of 2012.

Economists surveyed by Bloomberg News earlier this month expected the first rate increase to come in the fourth quarter of 2011. The Fed will raise rates from near zero in the first quarter of 2012, according to another Bloomberg survey.

One Size Fits All

Economic divergences in the euro area are making it harder for Trichet to set the ECB’s one-size-fits-all monetary policy. The debt crisis is damping growth in peripheral countries while northern European nations such as Germany power ahead.

The German economy, Europe’s largest, grew 3.6 percent last year, the fastest pace in two decades. The country’s inflation rate jumped to 1.9 percent in December.

By contrast, the Greek, Irish and Spanish economies shrank in 2010, according to European Commission estimates. Portugal’s is forecast to contract this year.

European governments are considering expanding their efforts to contain the crisis, which has already forced bailouts for Greece and Ireland. The plan includes aid for Portugal, debt buybacks, lower interest rates on rescue loans and guarantees against excessive debt, according to four people with direct knowledge of the talks.

European finance ministers will assemble a “comprehensive package” to tackle the crisis by March and discuss details of the “ambitious” program when they meet in Brussels next week, Germany’s Wolfgang Schaeuble said yesterday.

Bark or Bite?

Elga Bartsch, chief European economist at Morgan Stanley in London, said the crisis and tight credit availability will continue to damp growth in Europe and temper the need for the ECB to raise rates. “We expect the ECB to remain on hold until early 2012,” she said.

Still, policy makers are concerned that the inflation resulting from higher energy and commodity prices may trigger demands for higher wages, said Howard Archer, chief European economist at IHS Global Insight in London.

German chemical workers on Dec. 7 demanded up to 7 percent more pay, and the IG Metall union has asked for a 6 percent increase for workers at companies including Volkswagen AG.

The risk “is shifting toward earlier tightening” from the ECB, said Ken Wattret, chief euro-area economist at BNP Paribas SA in London. “We’ll have to see whether their bark is worse than their bite.”

To contact the reporter on this story: Matthew Brockett in Frankfurt at mbrockett1@bloomberg

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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