Renthusiast

Expected Move FacesWave of Objections Amid Fragile Recovery

By MONICA HOUSTON-WAESCH and G. THOMAS SIMS

FRANKFURT - By planning to raise interest rates amid a chorus of objections, Jean-Claude Trichet is embarking on his biggest gamble yet since assuming the presidency of the European Central Bank more than two years ago.The economic recovery of the 12-nation euro-currency zone is just picking up steam after several false starts, but patchy economic reports continue and inflation is starting to cool. That is helping to fuel a wave of opposition to the ECB as finance ministers, international think tanks and big unions argue that low rates still are needed for the nascent recovery.Despite this, Mr. Trichet strayed from a speech 13 days ago to read from a specially prepared note. His unexpected message: the ECB would at long last raise rates to curb incipient inflation. The move is widely expected to come today and would be the first time the ECB has raised rates in five years.During the ECB\'s previous one and only series of rate increases, the region was booming under the influence of the high-technology economy and the decision to raise rates was straightforward. This time it is different. Mr. Trichet, on the defensive ever since delivering his recent message, argues that keeping inflation low is the best way to promote growth and create jobs. The ECB chief fears for the bank's credibility after the bank overshot its inflation target for six of the past seven years. Lost credibility can ultimately result in even higher rates and lower growth, he says.Whether Mr. Trichet or his critics are right will unfold in the months ahead. At stake is the reputation of Mr. Trichet and the ECB. The health of the euro-zone economy, similar in size to the U.S., also hinges on the outcome. As a major global trading partner, Europe's well-being is crucial for the world economy. "The risk of a monetary-policy mistake by the ECB has never been higher," says Jean-Michel Six, chief European economist of Standard & Poor's Ratings Services in London. "They could raise rates too early and nip recovery in the bud, or too late and we could see significant inflation.""

Signs of inflation are beginning to emerge around the globe. The cause is largely higher energy prices. The price of oil is up some 50% this year. Central banks around the world have already begun increasing rates to tame inflation, with the U.S. Federal Reserve already raising rates at 12 consecutive meetings. Now the trend is finally reaching Europe.Europeans are particularly sensitive to higher rates now because growth is far lower and more uncertain than in the U.S., and unemployment is far higher at 8.4% compared with around 5% in the U.S.Mr. Trichet preannounced the rate increase just days after figures showed the euro-zone economy expanded 0.6% in the third quarter -- among the best quarters since 2000. Still, surveys suggest the recovery is hesitant. Overall sentiment for the euro zone slipped in November for the first time in five months, figures from the European Commission showed yesterday, raising speculation that a recovery once again will falter.On top of that, annual inflation slowed for a second consecutive month to 2.4% in November, figures also showed yesterday, down from a peak of 2.6% in September and closer to the ECB's goal of just under 2%. Mr. Trichet has said the bank today will revise its forecasts higher, bolstering the case for the higher rates.Many aren't seeing eye-to-eye with Mr. Trichet. "We see the planned increase ... as a burden to the fragile revival," said a spokeswoman for IG Metall, one of Europe's largest unions. They are frustrated that low wage increases of past years haven't yielded more jobs. Jean-Claude Juncker, the president of the euro-zone finance ministers, said this week that a rate increase could prompt unions to demand higher salaries, triggering the "second-round effects" that the ECB is trying so hard to avoid, as high energy prices spill over into broader price increases. The Paris-based Organization for Economic Cooperation and Development this week urged the ECB to wait until late next year to raise rates. Some economists worry that a rate increase could prompt the euro to strengthen against the dollar, halting a gentle recovery in industry.


If the economy falters, demands will likely grow for an overhaul of the bank. Italian Prime Minister Silvio Berlusconi long has called for the bank to focus less on its primary mission of inflation. By contrast, the U.S. Fed is mandated to focus on economic growth and employment as well as inflation. A number of European finance ministers want the ECB to coordinate policies with them. The bank fears that would encroach on its legal independence.The ECB's last rate move was a cut in June 2003 to a historically low 2%. Some ECB officials consider 2% an emergency rate to hoist the economy out of unusual weakness.The bank's effort to abandon its ultraeasy monetary policy is more than a year in the making. A year ago, the bank's Governing Council actively discussed raising rates. The ECB never carried through because of a slowdown that took it by surprise.Though the economic outlook hasn't changed much, the threat to inflation has, in the ECB's eyes. Loan growth has been soaring, prompting fears the bank's low rates might be fueling unsustainable rises in housing prices. Though prices are moderating, the ECB is unimpressed. Figures this week showed loans for home purchases soared an annual 10.8% in October from 10.5% in September. The ECB is also concerned that investors and consumers expect a pickup in inflation in the future.The bank's impending move says a lot about the ECB chief, in office since November 2003. Based on his actions, Mr. Trichet during the next six years will likely favor a pre-emptive strike against inflation and asset bubbles. Mr. Trichet has always pledged he wouldn't surprise the public by moving rates out of the blue. Last week, Mr. Trichet, despite his careful words, confused markets when he told the European Parliament that the bank wasn't now planning on a series of rate increases. An isolated move by a central bank is rare, and often meaningless in controlling inflation or steering growth. An assurance there won't be a series of increases "takes away the effect" for markets, says Thomas Mayer, European chief economist at Deutsche Bank in London."

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