ECB: Is Their Hawkish Rhetoric Meant To Signal A Rate Hike, or Just Manage Inflation Expectations?

With inflation pressures building rapidly and various ECB policy makers issuing hawkish commentary, the markets believe a rate hike by the central bank is essentially guaranteed in July. However, growth throughout the Euro-zone is slowing, as recent data has shown investor and consumer sentiment turning more pessimistic while business activity in the manufacturing and services sector has contracted. Clearly, the downside risks for the Euro-zone economy loom large, but with price stability being the primary mandate of the ECB, a rate hike may very well be on the way in just over a week.

Juergen Stark, European Central Bank Executive Board Member

“For reasons of credibility I think the ECB needs to look seriously at the current rate level given the high inflation expectations…We will not let ourselves be locked in over a long period of time, rather we will decide on a case-by-case basis what is necessary to guarantee price stability over the medium-term.” – June 21, 2008

“We have to look forward now and recognize that there are significant risks to price stability…At the same time, some companies in the services sector, where competition does not appear to be that strong, are raising prices massively. We cannot allow this…The issue is lasting growth. This cannot be achieved with an inflation rate of over three percent…People can feel their purchasing power eroding. We need to be very watchful that we don't reach the point of an upwards wage-price spiral.” – June 21, 2008

Lorenzo Bini Smaghi, European Central Bank Executive Board Member

“Unless technological innovations lead to substantial savings or to an increase in supply, the world economy will have to learn to live with continuously increasing commodity prices. For central banks, continuing to assume that these price increases are one-offs could put their credibility at risk…If the price of commodities, in particular food and energy which represent on average about 30 percent of the consumption basket in the euro area, increases at a yearly rate above 2 percent, as has been the case on average over the past 10 years, price stability can be achieved only if other prices rise on average by substantially less than 2 percent.” – June 20, 2008

“Experience has shown that if inflation is left to creep up, the cost of bringing it down later will be even higher. The central bank must ultimately act if this is what is needed to maintain price stability. All should be aware of this.” – June 20, 2008

BOE: In A Worse Position Than the Fed and ECB?

Like the ECB, the Bank of England is grappling with surging inflation as the most recent data shows that CPI jumped 3.3% from a year ago, the sharpest rise since the current series began in January 1997. However, unlike the ECB, the BOE has a dual mandate to maintain price stability and to promote sustainable growth and employment. The UK has already seen indications of a broad economic slowdown, but the combination of heavily indebted consumers and businesses and a collapsing housing sector puts the BOE in a particularly precarious position, as a rate increase meant to fight inflation could ease push the UK into recession. As a result, the UK's Monetary Policy Committee will likely continue to talk a big game on inflation in order to contain consumer inflation expectations, but when it comes down to it, they are highly unlikely to actually raise rates.

Mervyn King, Bank of England Governor

“This year, the squeeze on real income growth is likely to mean that both house prices and consumer spending weaken together…It is reasonable to expect the ratio of house prices to incomes to fall back, though with real interest rates still low by the standards of the past fifty years, not to previous averages.” – June 18, 2008

“Growth is now slowing quite sharply - broad money growth is falling, business surveys point to particularly weak output growth in the second quarter and growth is likely to remain subdued for the rest of the year…The rise in commodity prices cannot, by itself, generate sustained inflation in the United Kingdom unless we allow it to. We will not. So although inflation in the U.K. will rise in the short term, inflation will then fall back.” – June 18, 2008

Alistair Darling, Chancellor of the Exchequer

“We've got to make sure that we keep inflation under control because if we don't what will happen is that people may get a pay increase but every penny of it will be eaten up by rising prices in the shops…None of us want to see that happen, it's in no one's interest and that applies from the top to the bottom, public and private sector alike.” – June 22, 2008

Andrew Sentence, Bank of England Monetary Policy Committee Member

“So far, the fluctuations we have seen in price inflation have not affected pay increases noticeably…the inflation of that decade was very broad based, whereas the current pick-up in inflation is driven by rising energy and food prices. Now the prices of many other goods - such as clothing, footwear, hi-fi and computer equipment - are falling…Though we face upward pressure from rising energy and food prices, the MPC is firmly committed to bringing inflation back to the 2 percent target over a reasonable time frame.” – June 23, 2008

“Businesses and consumers are feeling the squeeze from higher fuel and food prices, while the difficulties in the banking system and a weakening housing market are adding to economic uncertainties…These factors should lead to much slower economic growth and a weaker labor market over the next year or so - helping to offset the upward pressure we are seeing on inflation from rising energy and food prices.” – June 23, 2008

John Gieve, Bank of England Deputy Governor

“We judge that in order for inflation to return to target it will be necessary for economic growth to slow this year, reducing the pressure on supply capacity of the economy and dampening increases in prices and wages. But the risks to both the upside and downside remain large…There is a risk that households and businesses may start to expect CPI inflation to be persistently above 2 percent.” – June 19, 2008

Richard Lee is a Currency Strategist at FXCM.