European Central Bank (ECB) Interest Rate Decision

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The European Central Bank (ECB) today made its critical interest rate decision, holding rates steady, but its hints of future rate hikes have intensified.

While the ECB kept interest rates steady, the tone of its discussion in the ensuing press conference was about as hawkish as possible for a central bank that was not yet acting on rates. ECB Chairman Trichet, joined by Vice Chairman Lucas Papademos, said the bank was "in a state of heightened alertness." He also stated, "we emphasize that maintaining price stability in the medium term is our primary objective." Trichet went on to say, "By acting in a firm and timely manner, we will prevent second round effects and insure that risks to price stability over the medium term do not materialize."

Talk About Signaling Future Action!

It's absolutely clear by these words that the ECB is at the precipice of rate increase. "The Greek" expects that some yet to come catalyst will lead to an emergency meeting soon, and that this hypothetical event that captures the alert bank's attention will initiate its intended action.

The Dollar Demon

We feel confident that the rapid strengthening of the euro against the dollar has been helping to hold Trichet's hand at bay up until now. We expect he seeks to avoid further damaging European industry competitiveness versus U.S. product, by waiting to raise European rates until similar action occurs in the U.S. So, Trichet's comments may signal more than just Europe's rate future, but might enlighten us to the one-on-one discussions he's probably had with Ben Bernanke. Thus, he's offered us a gift, and has become a Fed forecasting tool as well.

Europe's Good Reason for Concern

HICP inflation was measured at 3.6% in May, and has been above 3.0% for the past seven months. Europe suffers from the same price catalysts we do here in America, since global supply/demand imbalance is driving rising food and energy prices. The same factors that allow for American and European ongoing economic growth, when we suspect we would otherwise be in recession, emerging market development, is the same factor driving inflation. Well, it's one of the factors anyway. Of course, fiscal policy and increasing capital supply is also devaluing the dollar and also the euro, believe it or not (according to Trichet), helping to drive inflation.

Despite rising costs, real European economic growth managed a better than expected 0.8% in the first quarter. Trichet is cautious, however, and unwilling to trust in just one quarter's data before acting on inflation. He seemed to indicate that it might yet be a month or two before he would consider raising rates, barring an emergency catalyst. I say this because he referred to examining two quarters of economic data before acting.

Where Trichet's Vision is Blurred

Jean-Claude seems to have his hopes placed in a machine and a plan that has too many moving parts to possibly operate without flaw. First of all, he's assured that emerging markets will continue to support growth, and we have to agree on this point, though we see volatile dips and peaks ahead. Secondly, he and Bernanke expect food and energy prices to moderate in 2009. Sorry Charlie, these are secular factors driving necessary commodities. While industrial metals might see prices steady, we have a hard time seeing food and energy adjusting just yet.

Then, within Europe, he expects governments, company management and unions to obey him, and govern, operate and contract as he suggests. Here's the problem... Government's have the concerns of their electorate in mind first and foremost, because they do the voting, not broader Europe. Corporations have their profits at the fore, and corporate managers have their pockets at priority. Union leaders have their angry masses to obey. Nah, not gonna happen Jeannie baby. You're in for a tough time. All hell is about to break loose in Europe. It might be a good thing we can't afford to visit this year, since the unions might just shut the place down.

Jean-Claude speaks of no major national imbalances in Europe, but if you watch Greek news as often as I do, you have to disagree. The main topic of concern is the unfair price comparisons between Germany and Greece, and generally unmanageable cost of living increase. The average Joe, or Gus, has to work his professional job and a side job in order to survive. The other day, a mad group of 20 people raided a few supermarkets in Athens (I think), took food, and then distributed it to the people in a nearby plaza. Truck drivers are trucking en masse through the major centers, London and Paris, to demonstrate their concern with high fuel costs. I see disorganization in this union, and as we divorced know, it's the tough times that test a relationship. Start protecting your assets Jeannie baby!

An Interesting Aside (Our Obsession with Iran Again)

Trichet offered caveat that no major imbalances occur due to government protectionism or other events. Well, we've already seen protectionism in China and India with regard to rice hoarding and fuel price fixing. No matter, fuel price fixing just shifts the cost from civilians to the government, and then the government has to tax in the future to get money when it runs dry. We're dealing with communists, so do you really think protectionism will not occur when things get tough?

The Event

I would have to say that Iran qualifies as an "event," if not the main event. Did you notice Elhud Olmert was in town the other day? This just after President Bush visited him in Israel. Good to meet in person when you are worried about having your message bugged by, oh I don't know, the Russians?

We're getting closer to that broader imbalance my friends. "The Greek" has been thinking about this topic a lot lately, and so we'll spare you here, and give you a whole article on it later.

Conclusion

Barring event, we believe it's safe to infer that interest rates will be raised in both America and Europe before summer ends. It seems likely rates stick where they are through June though, given the comments from the Fed and the ECB. We're not sure these two modern day lion tamers can handle the lion when he hungers for oil prices that surpass $200 in rapid fashion. Bernanke and Trichet are lion tamers, trapped in the cage, and running out of meat. Good luck chaps, or should I say chops.

Note for New Yorkers: "The Greek" will be attending this event tonight, and will available to you for questions: Art Showing - Red Blood of the Dragon's Psyche

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