ECB, Poised to Raise Rates, Focuses on Indicator Fed Dismisses
Nov. 29 (Bloomberg) -- The European Central Bank is poised to raise interest rates this week for the first time in more than five years largely because of an indicator the U.S. Federal Reserve thinks isn't worth measuring any more.
M3, the broadest measure of readily available money in the economy, last month probably grew 8.6 percent from a year earlier in the 12 nations that share the euro, according to the median of 40 estimates in a Bloomberg survey. That would be the most in more than two years. The ECB publishes the data at 11 a.m. today, two days before the bank will probably raise rates, according to all 57 economists surveyed by Bloomberg.
An analysis of M3 forms one of the ``two pillars,'' along with an assessment of economic developments, in the ECB's interest-rate strategy. By contrast, the Fed said Nov. 10 it will stop reporting M3 on March 23 because the indicator's importance ``has diminished greatly over time'' and ``the costs of collecting the data and publishing M3 now appear to outweigh the benefits.''
More is at stake than a disagreement over economic theory. Economists such as Sandra Petcov at Lehman Brothers International in London say the ECB's reliance on M3 raises the risk that it is raising rates too soon, choking off economic expansion.
``The Fed and the ECB view monetary data completely differently,'' said Petcov. ``The emphasis the ECB places on this analysis is a little excessive. If we were in charge of interest- rate policy, we would keep them on hold.''
`Moderately Augment'
The ECB has held its benchmark interest rate at a six-decade low of 2 percent since June 2003, pumping money into the region's $9 trillion economy in an effort to boost growth. ECB President Jean- Claude Trichet referred to M3 last week when he said the central bank is now ready to ``moderately augment'' borrowing costs to keep a lid on inflation.
The expansion in M3 money supply has exceeded 4.5 percent, the level the ECB says is non-inflationary, every month since May 2001. The bank is also concerned workers will demand wage increases to compensate for higher energy costs. Surging oil prices have kept euro-region inflation, which was 2.5 percent in October, at or above the ECB's 2 percent limit for nine months.
``The risks of a price rise in the medium term have increased,'' Trichet said Nov. 24. ``Now those risks must be prevented from materializing.''
Still, so-called core inflation, which strips out energy and food prices, was at 1.4 percent in October, and consumer prices in Germany, Europe's largest economy, fell in November as oil prices retreated. Crude oil fell 19 percent since an Aug. 30 record of $70.85 a barrel.
Why the Hurry?
``So what's the urgency?'' said James Nixon, an economist at Barclays Capital in London who has worked as a forecaster at the ECB. ``There's a risk that if the ECB move too quickly, they'll squeeze all of the growth out of the economy, and that of course would be a disaster for Europe.''
The ECB's emphasis on money supply is a legacy of Germany's Bundesbank, which made its name fighting inflation before the euro was launched in 1999 and the ECB assumed control of interest rates in the 12-nation European monetary union.
Basing its strategy on restricting the flow of money through the economy, the Bundesbank had by the 1970s achieved the lowest inflation rates in Europe and turned the deutsche mark into one of the world's most stable currencies.
``Monetarist theory has it that if people have more money, they are likely to spend more, and if they spend more, prices are likely to go up,'' said Holger Schmieding, co-head of European economics at Bank of America in London. ``The problem is, how do you define money?''
Diminished M3 Role
As financial markets have evolved, the complexity of financial instruments and transactions has increased. The Fed acknowledged this when it said M3 data have lost their importance for interest- rate decisions as the world's financial systems have become more complex.
``I don't agree with the Fed approach,'' said Klaus Baader, economist at Merrill Lynch in London. ``I think the ECB's approach is a more intelligent one. The most damaging asset-price bubbles have always been accompanied by strong money and credit growth.''
The growth in the amount of readily available money on deposit in the euro region has this year been accompanied by an increase in lending. Some of that money is going into property, fueling house price gains of more than 10 percent in countries like France, Spain and Ireland.
`Not Mindless Monetarists'
ECB policy makers ``are not mindless monetarists,'' said David Mackie, chief European economist at JPMorgan in London. ``Money and credit growth are contributing to the inflation risk profile, and the ECB feels it's appropriate to lean gently against the wind. That seems perfectly reasonable to me.''
Defending the ECB's strategy on Sept. 21, Trichet said the bank's emphasis on money supply is justified because ``in the long run, inflation is a monetary phenomenon.''
``Certainly the ECB is a very staunch defender of monetary analysis,'' said Petcov. ``If you believe in the relationship between money supply and inflation, the trend is pointing in one direction only. But there are other factors which point to downside risks for inflation and for growth.''
An unemployment rate of 8.4 percent in the euro region, compared with 5 percent in the U.S., is constraining consumer spending, keeping wage pressures contained and weighing on economic growth.
Consumer spending in Germany contracted for a third successive quarter in the three months through September, the Federal Statistics Office said Nov. 23. German business confidence also fell in November, the Ifo economic institute said Nov. 24.
The Paris-based Organization for Economic Cooperation and Development will today predict growth of 1.9 percent in the euro region next year after 1.4 percent this year, according to a draft report obtained by Bloomberg News. By contrast, the U.S. economy, the world's largest, will expand 3.5 percent this year and 3.3 percent next year, according to the International Monetary Fund.
``With core inflation so low and unemployment so high, I would like to see growth at or above trend for a while before they start raising rates,'' Bank of America's Schmieding said.
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