Trichet admits he cannot please all

By Simon Kennedy  |   2008-7-1  |     NEWSPAPER EDITION

FOR all his talk of consensus, European Central Bank President Jean-Claude Trichet is having to acknowledge he can't please all of the people all of the time.

A rare public division on his 21-member governing council is forcing Trichet to take sides, backing those who want to raise interest rates this week to curb inflation. Doing so may open an ever bigger rift by easing price pressures in Germany, Europe's biggest economy, at the expense of weaker neighbors.

"I don't remember such an explicit split at the ECB," says Jacques Cailloux, chief euro-area economist at Royal Bank of Scotland Group Plc in London. "By lifting rates, the ECB will take unprecedented risks with growth."

Expansion in the 15-nation euro area is already deteriorating as costlier fuel, food and credit undermine household and company spending, and a strong euro and slowing global demand sap exports. As rates rise, the pain will be spread unevenly. The economies of Germany and France are holding up, while Portugal's is contracting, and growth in Ireland and Spain may be the slowest in 15 years, Bloomberg News said.

"Monetary policy could exacerbate this divergence if the ECB begins a sizable rate-hike cycle," says Laurent Bilke, an economist at Lehman Brothers Holdings Inc in London, who previously worked at the ECB.

Trichet surprised investors and economists on June 5 when he said there was "no unanimous" agreement among members of his council on whether to raise rates and signaled a bias toward an increase with talk of "heightened alertness" on inflation. Before then, not one economist out of 32 surveyed by Bloomberg News had predicted higher rates this year.

"Frankly, we didn't quite believe our ears when we listened to Trichet," says Erik Nielsen, chief European economist at Goldman Sachs Group Inc in London. All but two of 58 economists surveyed last month forecast the ECB on Thursday will boost its main rate a quarter point to 4.25 percent, the first rise in a year and the highest since 2001.

Forcing the ECB's hand is inflation that surged to 4 percent in June from a year earlier, the fastest in 16 years and in breach of the central bank's target of just below 2 percent for a 10th month. A European Commission poll of 30,170 citizens last week showed rising prices overtaking unemployment as their main concern.

"The ECB is facing elevated inflation risks," says David Mackie, chief European economist at JPMorgan Chase & Co in London. "The idea that a 4-percent rate is enough doesn't seem convincing."

The risk for Trichet is that a strike against inflation now delivers a crippling blow to the euro zone's more fragile economies. Reports last week showed manufacturing and services industries in the region unexpectedly shrank in June, confidence among consumers and businesses fell more than economists forecast and retail sales plunged.

A widening continental divide is the price of a "one-size-fits-all" monetary policy, says Nick Kounis, an economist at Fortis Bank NV in Amsterdam. "The ECB is not that interested as it sets policy for inflation °?°?- not for growth," he says.