A couple of weeks ago, the EUR moved sharply upwards against the USD after Jean-Claude Trichet said at his press conference that he expected inflation to rise and that the ECB committee would not pre-commit to not raising interest rates. I have drawn an ellipse around the relevant day.
Bloomberg’s headline was Trichet Shifts to Inflation-Fighting Stance as Europe Battles Debt Crisis, and that is how markets and many commentators took the announcement, despite the measured tone of JCT’s comments.
As I said in my daily markets update
the following day, I thought the whole episode was about politics. First, Trichet did not want to support PIIGS sovereign bond markets for very long, and wanted to signal to Eurozone governments that they should take seriously the nascent idea of further governmental measures to deal with the debt crisis — by saying, in effect, “You can’t count on me indefinitely.” Second, Trichet speaks for the whole ECB committee at his press conferences (unlike, say, Ben Bernanke in his irregular public statements) and there are some well-known inflation hawks on the committee. And third, the ECB has a mandate to keep inflation below but close to 2%, and the latest number is higher; in order to keep people from losing faith in the ECB and hence increasing their inflation expectations, Trichet rather uncontroversially reminded the world that the committee is not committed to not fighting inflation, if it becomes a problem.
I am feeling vindicated by events. Last week there were attempts
to moderate the markets’ expectation for rate increases, and today there are reports that Trichet himself has said
the markets have got ahead of themselves on that score. But the point of this post is not (OK, “is only partly”) to record my petty triumph. This episode is a good illustration of two important facts about the market:
- Newsflow and reality are different things. The headlines can say “ECB switches to inflation-fighting stance” — which, incidentally, would be a very important shift — while the reality remains “ECB unlikely to raise interest rates.”
- Markets do not get politics. When they notice what political actors are saying, they tend to take them at their word; they generally think that political actions are aimed at them and do not understand statements made for the benefit of other constituencies; and most of the time, they ignore politics altogether.