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Trichet Moves to Inflation-Fighting as EU Bats Crisis

ECB President Jean-Claude Trichet
European Central Bank President Jean-Claude Trichet said that the ECB’s monetary policy and its crisis-fighting measures are different and “disconnected’. Photographer: Hannelore Foerster/Bloomberg

European Central Bank President Jean-Claude Trichet signaled he’s prepared to raise interest rates if needed to fight inflation even as leaders struggle to contain the region’s sovereign-debt crisis.

“We are permanently alert, we are never pre-committed not to move interest rates and our level of interest rates is designed to deliver price stability,” Trichet said at a press conference in Frankfurt today. At the same time, the benchmark rate, which the ECB left at 1 percent, is still “appropriate.”

Trichet is trying to keep a lid on inflation without roiling financial markets spooked by the euro region’s fiscal crisis. While increases in consumer prices exceeded the ECB’s ceiling for the first time in more than two years in December, higher interest rates would saddle debt-laden countries such as Ireland, Greece and Portugal with still higher borrowing costs.

The yield on German two-year bonds jumped 12 basis points to 1.103 percent after Trichet’s comments. The euro rose to $1.3326 at 5:05 p.m. in Frankfurt, compared with $1.3206 before the press conference.

“We see evidence of short-term upward pressure on overall inflation, mainly owing to energy prices, but this has not so far affected our assessment that price developments will remain in line” with the ECB’s definition of price stability, he said. “Very close monitoring of price developments is warranted.”

Conditional Warning

Trichet may be trying to discourage a pass-through of higher commodity prices to consumer inflation, said James Nixon, co-chief euro-region economist at Societe Generale in London.

“It’s a conditional warning -- ‘we will increase interest rates if inflation doesn’t moderate as we currently expect,’” Nixon said.

With divergences between euro-region economies widening and market turmoil threatening to spread to the Iberian peninsula, the ECB faces a challenge in timing the exit from government-bond purchases and providing unlimited liquidity for banks.

Inflation expectations have more than doubled since August, with the gap between the yields on five-year German nominal bonds and similar-maturity index-linked debt climbing to 1.5 percent yesterday. Euro region consumer prices rose 2.2 percent in December.

At the same time, banks in peripheral economies remain dependent on central bank funding. ECB financing of Portugal’s banking system will remain “significant” through 2012 as financial institutions are facing “persisting difficulties” to access funding in the market, the Lisbon-based central bank said yesterday.

Rate Forecast

Lawmakers from German Chancellor Angela Merkel’s Bavarian allies, the Christian Social Union, told Trichet on Jan. 7 that the ECB should refocus on its core inflation fighting remit and limit its bond purchases. Economists forecast the bank will raise its key interest rate in the fourth quarter of this year, a Bloomberg survey shows.

“We could alleviate the non-standard measures whilst we are decreasing or augmenting the interest rate, and we could increase the non-standard measures while we would increase or augment the interest rate,” Trichet said. “The two modes are disconnected, they are not correlated.”

The ECB said last month it will keep liquidity measures in place through the first quarter. Bond purchases, which so far total 74 billion euros ($98 billion), are “ongoing,” Trichet said.

Not Proceeding

“The language suggests that the Governing Council at the very least will not wish to proceed with full allotment for three months after March,” said Julian Callow, chief European economist at Barclays Capital in London.

Some ECB policy makers have warned that price stability, the bank’s primary goal, could be compromised if emergency measures are left in place too long. Withdrawing them too soon could frighten markets and push up the interest rates stricken nations have to pay on their debt, exacerbating the crisis.

Spanish borrowing costs increased in an auction of five-year bonds today. Spain will pay an average yield of 4.542 percent on the new securities, up from 3.576 percent at a similar auction in November. Italian borrowing costs increased to 3.67 percent at a sale of five-year securities today from 3.24 percent the last time they were sold on Nov. 12.

“We are asking authorities to be up to their responsibility and this has been our message for months,” Trichet said. “There is a sense of urgency.”

Crisis Talks

Trichet’s comments come as European governments consider aid for Portugal, debt buybacks, lower interest rates on rescue loans and guarantees against excessive debt as part of a package to quell the financial crisis, according to four people with direct knowledge of the talks. The plan would mark an attempt to contain a crisis that’s spread from Greece to Ireland and is threatening to infect Portugal and Spain.

Trichet said the fund should be increased and given “maximum flexibility.”

“Today’s strong wording suggests that the ECB may act earlier than we have expected so far,” Juergen Michels, chief euro-region economist at Citigroup Inc. in London said in a note as he brought forward his forecast for a rate increase from the first quarter of 2012 to the second half of the year. “However, the ECB is likely to keep the non-standard measures in place for long and probably will even extend the measures in order to deal with the sovereign debt crisis.”

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