German Consumer Prices Drop

While Japan celebrates the minor victory of stopping the fall in consumer prices, Germany has just registered a month on month drop of 0.5 percent from October to November according to figures just out from the Federal statistical office. Of course most of the drop was brought about by a fall in the 'volatile elements', but still, hardly justification from a rate tightening exercise at the ECB, as the ever perspicatious Paul de Grauwe was arguing in the FT yesterday:

So it was quite surprising that several ECB policymakers came out arguing that the interest rate would have to increase in December. Sensing trouble, Jean-Claude Trichet, ECB president, announced unexpectedly that a rate rise in December was all but inevitable.

It is difficult to understand such a turnaround. One can only guess what underlies this “volte face” that put the financial markets on the wrong foot. Here is my explanation, which I cannot prove but which seems to make sense. There is a hard core of “hawks” in the governing council who cherish a monetarist agenda. This agenda has two items. One is to bring the rate of inflation back below 2 per cent, the only target the ECB has declared to be salutary and consistent with price stability. The second is to curtail the “excessive” growth of the money stock, M3, which has now reached an annual rate of 8 per cent (but this was also the case two weeks ago when the ECB declared that this was not sufficient to raise the interest rate). The hawks somehow managed to have the upper hand in the governing council and to make the president their spokesman when he came out declaring that a rate increase now had become necessary. This statement also makes a rate increase almost inevitable next month.