Europe's top central banker is reminding markets and European politicians that his No. 1 task is to control inflation for the continent, even when higher borrowing costs are the last thing its most-indebted nations need.
Jean-Claude Trichet, president of the Frankfurt-based European Central Bank, raised his benchmark interest rate by 25 basis points Thursday, to 1.5 per cent, and signalled that at least one more increase is in store before he is succeeded by Italy's Mario Draghi in November. The move came as policy makers weigh a volatile debt crisis against the risk that wage and price pressures in Germany, the region's biggest and healthiest economy, could spread.
At the same time, Mr. Trichet threw a crucial lifeline to Portugal that the ECB has already extended to Ireland and Greece, and to Europe's political leaders, by choosing to ignore downgrades by ratings agencies and pledging to keep allowing those countries' banks to swap sovereign debt for fresh loans.
The ECB's balancing act highlights the delicate job of central banks in areas with huge economic and financial disparities, especially those governed by a narrow mandate such as keeping inflation from advancing beyond a specific pace. Bank of Canada Governor Mark Carney faces similar challenges, with high commodity prices threatening to spark broader inflationary pressure while many exporters are struggling and some households are drowning in debt.
Unlike Mr. Trichet, though, Mr. Carney isn't trying to help stem a sovereign debt crisis that, if exacerbated even slightly, could scuttle the continent's sluggish recovery and potentially tip the global economy back toward recession.
“I wouldn't want his job for anything,” Camilla Sutton, chief currency strategist at Scotia Capital in Toronto, said of Mr. Trichet. “I wouldn't be surprised if, when history comes to judge this, it turns out to be a flawed moment. But for now he's really sticking to his mandate and thinking that the periphery is a small part of Europe, and just like the Bank of Canada is forced to establish policy based on Canada as a whole, Trichet is following exactly that principle.”
To be sure, inflation in the 17-nation euro zone has topped the ECB's 2-per-cent limit for seven months now, conditions that in normal times would argue squarely in favour of rate hikes. But even as Germany's export-heavy rebound lifts the continent's overall rates of growth and inflation, other major central banks are standing pat for fear of sending their still-fragile economies into a tailspin.
The Bank of England, for instance, on Thursday kept its main interest rate at 0.5 per cent, as the economy of the United Kingdom – much like many inside the euro zone – buckles under the weight of brutal belt-tightening measures designed to fix the fiscal side of things.
The U.S. Federal Reserve Board, meanwhile, is expected to maintain near-zero interest rates for several more months, a stance made more palatable because the Fed has a dual mandate of controlling inflation while also fostering “maximum employment.” With the U.S. jobless rate above 9 per cent, it is clearly far from achieving that.
Mr. Trichet was unfazed Thursday when grilled about the effect that his tightening could have on the debt crisis, in a week when European bond yields soared to record levels as markets lost faith that the continent's political leaders can contain it. The ECB president has argued that his job is to keep price gains from spreading, while politicians need to forge ahead with austerity.
“I have a lot of questions on Ireland, Portugal, Greece,” he told reporters at a press conference Thursday, according to Bloomberg News. “Shall I remind you that we're responsible for price stability for the euro area as a whole? Those issues which you're addressing constantly should be addressed to governments, they're responsible.''
Some economists argue that Mr. Trichet is on solid ground attacking inflation before it gets out of hand, since rapid price gains would hardly be a bonus for the European economy, and that other policy makers like Mr. Carney should take notice.
Stéfane Marion, chief economist at National Bank Financial in Montreal, noted that the ECB opted to raise rates at a time when unit labour costs are actually rising at a far slower pace than in Canada. Mr. Carney is “playing with fire” by keeping his benchmark interest rate at 1 per cent while the annual rate of inflation is approaching 4 per cent, Mr. Marion suggested.
Still, Mr. Carney has kept rates steady because, in his words, the Canadian economy faces “considerable headwinds” that will help restrain inflation. Also, there's a strong case to be made that as growth slows around the world and demand for commodities evens off, price gains will be more manageable than Mr. Trichet seems to fear.
Indeed, while the debt crisis makes Mr. Trichet's current predicament unusual, it is widely acknowledged that the ECB's aggressiveness in trying to tame inflation three summers ago while oil prices were soaring left the European economy unable to avoid joining the global slump.
“Let's not mince words: One of these central banks is making a mistake,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns. “Either the ECB is tightening at precisely the wrong moment (à la 2008), or the [Bank of Canada] is at risk of falling dangerously behind the curve. Only time will tell, but it seems the ECB is taking the much bigger risk.”