There’s more than one way to run a central bank, which inevitably leads to the possibilities of success or failure. The trick is figuring out if one or the other’s likely and if the expectation is already priced into bonds and other assets.
With that setup, we turn to the yesterday’s announcement by the European Central Bank to hold rates steady and keep its benchmark borrowing rate at 4.0%. In the related press conference, ECB president Jean-Claude Trichet made it clear that rising inflation played a role in the decision.
For the casual observer, taking a tough stand on inflation may seem like an easy choice for a central bank, but investors shouldn’t assume that the ECB’s hawkish disposition is the default position.
Witness the Federal Reserve of late, which finds it far easier to cut than stand firm. In fact, Fed chief Bernanke yesterday signaled that even more rate cuts are coming. “In light of changes in the outlook for and the risks to growth, additional policy easing may well be necessary,” he said in a speech in Washington. “We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”