The risk of an ECB about turn

Quite a few parallels are being drawn between the current situation with food and energy prices and that being seen in 2008.   Food prices, looking in absolute but general terms (i.e. the Economist index) are now higher than was the case back then. Food price inflation isn’t as high, but is certainly moving up.

Guest post by  FxPro

For policy makers, the risks are similar.   Should central banks focus on the inflationary threat, or look to accommodate the push higher in headline inflation, on the basis that more often than not these things come out in the wash? Furthermore, there is the impact on the economy to consider, with higher prices acting in many ways the same as tax on consumption, leaving less money to spend on the other essentials and non-essentials.

The ECB chose to put rates up in July 2008 on the basis of inflation moving higher.   However, this move was reversed a mere three months later, soon after Lehman’s had gone to the wall.   Naturally, we’re not (well, hopefully not) in the same position now in terms of such a high-impact event coming to pass, but there are still considerable underlying risks, most notable the situation in the Middle East and, more specifically, that it causes a further substantial push higher in oil prices.

In the early part of last year the ECB pledged to pull back from its plan to supplying markets with unlimited liquidity at its various repos.   The sovereign debt crisis soon put a stop to that, with the ECB again to perform an about-turn to ensure confidence was maintained within the banking system.   They are keen to try the same again and may start to do so at this week’s meeting.

Unfortunately only time will tell, but the risk of another about turn from the ECB, either on liquidity provision, having to scale back its previous hawkishness or even reverse any eventual tightening, is a risk that should be carefully considered.

Simon Smith

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