ECB fight against inflation a tough sell as economy stumbles

July 20, 2008
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, FRANKFURT, July 20 – The European Central Bank is trying to convince people in the eurozone that taking a tough stand on inflation will get them through lean economic times, arguing that long-term gains warrant short-term pain.

"There is a particular need to speak to citizens on inflation and monetary policy right now," Natixis economist Sylvain Broyer said after ECB president Jean-Claude Trichet laid out the bank\’s stance in an interview with four major eurozone newspapers.

Public opinion is emerging as key ground to be won since the bank raised its main lending rate despite signs that economic activity was slowing sharply in the 15-nation eurozone.

Politicians have urged the ECB to ease policies that determine credit conditions for around 320 million people, though they know its main goal is to keep inflation, which hit a record 4.0 percent last month, in check.

The ECB argues that sustainable growth is best served by making sure people know the bank will target inflation of just below 2.0 percent, even if that means letting the economy contract for some months.

"So far it\’s been easy," commented Bank of America economist Gilles Moec, pointing to low interest rates a few years ago when many questioned whether inflation had finally been beaten.

"I don\’t think any politician in France or Italy dreamed of seeing interest rates at 2.0 percent just three years after monetary union" in 1999, he said, referring to conditions that also fueled housing booms in countries like Spain and Ireland.

"Now we\’re getting into the territory where it hurts, where its painful."

Like economies around the world, the eurozone has been hit by high oil and food prices and tighter credit sparked by the global financial crisis that have eaten away at household budgets and curbed spending on many non-essential items.

Eurozone exporters are also hampered by the euro\’s rise to record highs above 1.60 dollars that make their products more expensive abroad, and weaker economic conditions in key trading regions that have reduced demand further.

The eurozone\’s trade balance fell into deficit in May, while industrial output slumped and growth forecasts were scaled back.

That has forced Trichet to make his case to the public, which he often does by referring to "the poorest and the most vulnerable that can do the least to protect themselves from rising inflation."

He argues for example that rising wages following the oil shocks of the 1970s created mass unemployment in Europe, compared with 15.7 million jobs generated since the single currency was born nine years ago.

"Speaking to several newspapers is a good way to communicate to the wider public," Commerbank economist Michael Schubert commented.

The central bank\’s policy he added, "completely depends on inflation expectations," or widespread belief that prices will rise sharply or not in the future.

That can influence decisions from whether or not to buy a home appliance to business investments involving tens of millions of euros or long-term interest rates that require governments to pay massive sums to finance their budgets.

Moec said he thought Trichet\’s remarks were addressed to European leaders who seek to influence the ECB, the independence of which was laid down in the Maastricht Treaty.

"Let\’s not get into a debate on the mandate," was the message Moec heard, "because we already have systems in place" to ensure politicians\’ views were heard.

While ECB independence is firmly established, efforts to gain influence "could have some consequences if it was seen elsewhere, especially in the US or the UK, that there is some internal fragility in the system," the Bank of America economist said.

Broyer at Natixis also saw tension building between European Union leaders like French President Nicolas Sarkozy and the ECB, saying: "I think it will enter a more strained phase."

The euro\’s success would "radically transform the European economy" and force governments to reform obsolete industrial methods, with the past nine years just "the beginning of the phenomenon," he added.

"What does not work today is the European political model," Broyer said after Ireland rejected the EU\’s draft Lisbon Treaty designed to ease future englargement.

Sarkozy is to visit Ireland Monday to explore ways of resolving the snub.

"We need common economic and social policies and it is up to Sarkozy and his friends to do it," Broyer said.

Instead of trying to deflect public discontent onto the ECB, politicians should acknowledge "they are unable to get Europe moving, as we saw again with the Irish \’No\’."

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