The hike was 25 basis points, but raising interest rates by 50 bips was considered, European Central Bank president Jean-Claude Trichet said today after the monetary tightening. “The overwhelming majority of the governing council thought that a 25-basis point increase was appropriate,” Europe’s top banker reported at a news conference today, according to RTE Business. “But we did weigh the assets and liabilities of a 50-basis point rise.”
In the United States, the Federal Reserve was recently considering zero as the operative change for the next change in interest rates but has since decided that a 25-basis-point elevation is the more prudent choice after all, or so Fed futures are predicting.
The pressure from abroad to elevate the price of money is rising on the American central bank, if only to keep the yield premium intact relative to the primary paper alternative to the dollar. That pressures promises to be an ongoing one for the foreseeable future, Trichet advised. “If our (recovery) scenario is confirmed, then further withdrawal of monetary accommodation is warranted,” the ECB chief said. For the United States, which relies in no small part on foreign purchases of Treasuries to fund the government’s deficit, paying attention to the relative attractiveness of government bonds is a big deal.
With the latest hike, the ECB benchmark refi rate is 2.75%. That’s still a long way from the current 5.0% Fed funds, although the gap is, for the moment, narrowing. In fact, the ECB’s tightening, and its stated intention to perhaps offer more of the same down the road, has marginally reversed the dollar’s recently rally this morning. A warning sign, if you will, albeit a small and so far marginal one. But with the threat of marginally enhanced competitive yields abroad, forex traders have decided sell the greenback for the moment if only to reconsider the in days and weeks ahead.
The Fed’s response, if any, to rising rates in Europe will come at the end of the month, when the FOMC convenes again on June 28/29.
Adding to the general aura that another rate hike is need for the U.S. is the latest forecast by the White House, which, presumably, is inclined to soft pedal this outlook for political reasons. All the more reason then to consider that the Bush administration says inflation will average 3.0% this year, up from its previous 2.4% prediction.
If the stars are aligning for another rate hike, the bond market finds the trend encouraging. The yield on the 10-year Treasury at one point in early trading today dipped ever so slightly below the 5.0% mark, suggesting some confidence that the Fed will in fact err on the side of caution when it comes to the recent spate of inflationary pressures.
If there’s a renewed commitment to nip inflation in the bud, the bond and stock markets could yet face more turbulence as investors digest the proposition. But if the Fed can keep its statements focused on the long haul, and avoid speculating on the next data point release, perhaps there’s a chance for rallies in stocks and bonds as the summer proceeds. The capital markets like nothing better from their central banks than promises of stability in prices and a committed, long-term focus on pursuing just that. But lest we get too optimistic, let’s also remember that the new era of central banking (i.e., one where disinflationary winds are no longer blowing free and easy) has only just begun.