· The inflation trends tell the story. It’s a clear story of angst at the ECB. The sequential growth rates (3Mo Vs 6Mo Vs 12Mo) show a steady quickening of the pace of inflation in the more recent time periods. Over
12 months (ECB’s preferred horizon) three of our four key EMU
countries show ex food ex energy and ex alcohol inflation at a pace above the ECB ceiling. Over the more recent periods that situation has only gotten worse. As to headline inflation: forget about it. The history on the graph
on the let shows that once headline inflation spurts the core rise usually follows in a year or so. The year 2005 was an exception when the core fell by itself. There is nothing automatic about headline-> core inflation transmission. But there is enough correlation to make the ECB’s fears of second or third round effects real. On top of that the current core pace is simply unacceptable.· If the multi-central bank dollar credit facility is ‘successful’ it could hasten the time when the ECB hikes rates. Whether that widens interest differentials with the US depends on whether US circumstances normalize and whether such normalization brings with it a rebalancing of the economy (where consumer confidence is sagging so badly and in a way that it does not appear to be wholly determined by credit market issues).
· While the credit turmoil, crisis, scam or whatever you may want to call it, is a real and essentially global phenomenon, it is not the only concern in town. And that applies to the evolution of European growth as well as in the US. In Europe arguably much of the outlook hangs in the balance on what the euro does from here on out. What inflation does and how the ECB responds to it will be a large par of that.