A smart move by Trichet and the ECB?

032a8fd7dc5373.jpg As the European Central Bank chooses to raise the interest rate by a quarter percent it is fair to ask why? The large European economies are still showing really sluggish growth signs so the reason cannot be found here. The other plausible reason is that the ECB is trying to establish its credibility as a central bank keen on keeping inflation at bay.  However don't take my word for it - read this article from the Economist which provides a good overview.

"The bank is trying to establish its credibility as an inflation hawk, but this may be hard to do without endangering the fragile recovery in some of the euro zone’s biggest economies."

So, is the ECB trying to navigate in too narrow waters here? It could seem so. A raise in the interest rates albeit a very small one probably won't have any actual effect but markets and consumer confidence in especially France and Germany are volatile so the effect might in the end be real enough in terms of thwarting a growth that is yet really to pick up.

And then there is the inflation. True, the ECB target of 2% has been exceeded by 0,4 percent at the end of the year but the question still remains of why and how a raise of 0.25% could be merited. If it is to show financial stakeholders that an inflation target is not to be joked with the strategy this is a very narrow point of view and many other of the ECB stakeholders would rather want it the other way around.

"Mr Trichet has to worry not only about the markets, but also about the politicians and interest groups who are vehemently opposed to any tightening. In the days leading up to the rate rise, bankers joined trade unions and business leaders in complaining that higher interest rates would endanger the slow recovery and throw people out of work."

In my opinion though, it would be fair to cut Mr. Trichet and the ECB some slack. Managing the financial condition of 25 very diverse countries is not an easy task and trade-offs are bound to show their ugly face. The real dilemma as also reported by the Economist is that growth rates are very different across the eurozone ... what to do?

"This presents the ECB with an unappetising choice: slow down the fragile recovery in economies like Italy’s, or run the risk that more robust countries will overheat. (...) Its biggest economies are burdened with a number of structural flaws, in particular rigid labour markets. Ill-fitting monetary policy exacerbates these but it does not cause them, and it cannot fix them"

This post by the Neweconomist also serves as a good hub for the dicussion of the ECB's dilemmas as well as this post at AFOE by Edward Hugh