Confused Trichet Walks Tightrope on Liquidity, Rate Hikes, Greece; Reflections on Unexpected Things

The US dollar is a bit firmer vs. the Euro in the wake of a Trichet's comments regarding "strong vigilance", code words for a "hike is coming" at the next meeting.

Trichet also got into a pissing match with German finance minister Wolfgang Schaeuble who said bondholders must contribute a substantial share of a second aid package for Greece. Schaeuble proposed a 7-year maturity extension that credit-rating companies say would constitute a default.

The rest of Trichet's prepared words were certainly more dovish than hawkish, with a pledge to provide "unlimited liquidity".

Please consider ECB's Trichet flags July rate rise, hardline on Greece

"On balance risks to the outlook for price stability are on the upside, accordingly strong vigilance is warranted. On the basis of our assessment we will act in a firm and timely manner," Trichet told a news conference after the ECB kept its main refinancing rate at 1.25 percent.

Trichet said evidence since the ECB's May meeting confirmed "continued upward pressure on overall inflation mainly owing to commodity and energy prices."

But wary of choking off support too fast, the ECB would continue to provide banks with unlimited liquidity to support the recovery, he said.

Trichet said evidence since the ECB's May meeting confirmed "continued upward pressure on overall inflation mainly owing to commodity and energy prices."

Beyond July, Trichet left the ECB's options open, saying: "We are not signaling any particular pace for the next decisions on our interest rates."

German Finance Minister Wolfgang Schaeuble, facing domestic pressure to involve the private sector in any new Greek bailout, earlier this week demanded a "quantified and substantial" contribution from bondholders as part of any new package.

Schaeuble also suggested extending the maturities of outstanding Greek debt by seven years. Trichet's comments appeared to underline his opposition to such pressure.

"I am not embarking on a dialogue with a particular minister here," Trichet said.

"We are not in favor of restructuring ... and so forth," he said. "We exclude all concepts which would not be purely voluntary, without any elements of compulsion. We call for avoiding any credit event and selective default, say. And of course, default."

Asked if the ECB would roll over its own Greek bondholdings, Trichet replied: "It's certainly not our intention."

Commodity Excuse is Lame

Central banks hike when they want to, or when the market forces them to, using whatever excuse they want at the moment. The excuse now is rising commodity prices.

The fact of the matter is commodity prices are rising primarily because of a torrent of unsustainable infrastructure malinvestment in China in conjunction with peak oil. One can also blame policies at the Fed, especially QE2.

As such, and from the perspective of Europe, there is little inflationary about it.

Trichet Clearly Confused

Perhaps a rate hike is warranted, perhaps not, but Trichet's confused comments don't help.

Moreover, if inflation is a problem, why should a central bank pledge "unlimited liquidity"? Are we to believe a hike from 1.25 to 1.5 percent will cure the inflation problem, so much so that the ECB can continue offering "unlimited liquidity"?

Walking Multiple Tightropes

Trichet is walking multiple tightropes simultaneously, partly out of his own foolish stubbornness and partly because of flaws in the structure of the Euro-Zone policy itself. Thus, it's no wonder he sounds confused.

He has only himself to blame for the ECB's balance sheet being loaded to the gills with garbage from Greece and Ireland. Much of the rest of his problem has to do structural problems in Maastrict Treaty that created the European Union. Given that he was one of the architects of that treaty he can blame himself for that as well.

Regardless, interest rate policy of "One Size Fits Germany" is not tenable in practice. Recognition of that predicament is what led Trichet to propose major changes in the treaty.

For a discussion of what Trichet now wants, please see Trichet Calls for Creation of European "Nanny-State" and Fiscal "Nanny-Zone" .

Is Another Hike Suitable Even For Germany?

For now, Trichet has signaled his intention to get in another hike. I am wondering "Is a hike even the right policy for Germany?"

In case you think it is obvious, please consider German Industrial Output Unexpectedly Fell in April on Construction Slide

Jun 8, 2011

German industrial production unexpectedly declined for the first time in four months in April, led by a drop in construction output.

Production fell 0.6 percent from March, when it rose a revised 1.2 percent, the Economy Ministry in Berlin said today. Economists had forecast a gain of 0.2 percent, the median of 36 estimates in a Bloomberg News survey showed. In the year, production rose 9.6 percent when adjusted for working days.

Reflections on Unexpected Things

Consensus is this is a "moderation" in growth not a halt of it. Perhaps.

However, it might also help to know that Industrial production "unexpectedly" dropped .9% in France, and consumer spending "unexpectedly" plunged in Italy.

Of course job growth "unexpectedly" plunged in the US and the unemployment rate "unexpectedly" rose.

Also in the US, there was an "unexpected" plunge in the ISM, in new orders and order backlogs. Please see Mish on Yahoo Finance Daily Ticker on Slowing Global Economy; U.S. Manufacturing ISM Plunge; Order Backlog and New Orders Barely Above Contraction for details.

The number of consecutive "unexpected" things that has surprised economists is rather amusing. Once again I suggest that economists are an amazingly optimistic lot smack in the face of a global economy that is clearly slowing.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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