Euro Update (12): Talking down inflation fears and rising momentum for expansion of EFSF

In a recent post I mentioned that inflation fears had led to an increase in the monetarily conservative tone of the rhetoric emanating from the ECB’s Frankfurt’s headquarters. According to media reports (e.g.:Bloomberg), these seem to have faded away as fears of an expectation led real economic crash ensued. In the game of chicken between the Member states and the ECB, the Member states win. Even the usually loose tongued Weber has calmed himself. Might as well, until March inflation values will be biased by energy costs and may therefore not reflect the actual economy. Notwithstanding this though, I wouldexpect inflation to rise in Germany with wage growth (for Deutschbahn (1.8% and 2%) and utility (3.4%) workers at least) finally arriving to our Teutonic friends. Plus there’s all that inflation we’re starting to import from China.

Instead the members of the Governing Council of the ECB may have opted for an alternative strategy. Instead of threatening the member states with rising interest rates, the ECB may have figured out it is better to tone itself down on inflation fears, while it can, and provide some positive reinforcement to fiscal rescue. By joining their voices to that of Jean Claude Juncker the need for more flexibility for the EFSF and other lending facilities, it is basically arguing for the weight of fiscal rescue to be lifted off its shoulders. If the ECB can manage to convince member states to expand the EFSF, in size and scope, the economies of the south may stabilize just enough to allow it to tighten interest rates a bit when it needs that. This idea is supported by recent and repeated reports of members (Chief Economist Stark and President Trichet ) of the ECB Governing council calling for reform of the EFSF in this manner.

In the mean time, member states and the commission continue to wrangle around, discussing the minutia of the agreement(as Reuters and the Economist thoroughly explain in this and this article, respectively). As mentioned before, the European Commission wants the Euro-zone to find agreement on an EFSF with expanded size and scope before the beginning of February (preferably before the 9th) when member states are expected to go to the markets with sovereign debt auctions. Germany understands the needs of the member states, but want a more encompassing compromise with more quid pro quo. It justifiably, but wrongfully, feels, it is paying someone else’s bill without much in return ( Portugal, Spain, Ireland and Greece have expanded the market for German products and credit to a total of approximately 73 million people with fairly uncompetitive producers. I’d call that quid pro quo…)

I guess it’s only a matter of time by the end of next week, everybody should have set the dates for their debt auctions which should then let the market start signaling it is not happy with the present state of affairs, by dumping the bonds of these countries. May be it’ll force everyone’s hand… May be it won’t. We’ll have to wait and see.

In the mean time the IMF puts the EU to shame by approving a new $30 billion credit line for Poland. I know it’s not fair to compare the two, but still, it’s quite embarrassing for Brussels…

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This entry was posted in ECB, Euro-zone Update, European Interdependences, Inflation, Sovereign debt Crisis and tagged , , , , , . Bookmark the permalink.

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