ECB may raise rates if inflation pressure increases

The European Central Bank may raise rates if inflation pressure increases, even after it pledged to keep borrowing costs low, according to Germany’s Bundesbank.

The ECB’s commitment “is not an imperative statement, and it doesn’t represent a change” in the monetary policy stance, the German Central Bank said yesterday in its monthly report.

“Forward guidance doesn’t rule out an increase in the benchmark rate if greater inflation pressure emerges.”

ECB president Mario Draghi said in July for the first time the ECB will keep interest rates at current levels or lower for an extended period of time. He reiterated his statement this month, trying to assure investors that the Frankfurt-based central bank won’t tighten policy too soon after it cut its benchmark rate to a record low of 0.5% in May.

“It is decisive to note that this statement is conditional” upon the unchanged obligation to guarantee price stability, the Bundesbank said. “Therefore, the euro system’s forward guidance doesn’t represent an unconditional promise about the future path of the benchmark rate.”

While the ECB’s forward guidance is different from that provided by the US Federal Reserve because it doesn’t set thresholds for unemployment or inflation, there are also similarities, the Bundesbank said.

“It has to be emphasised that both central banks base their forward guidance on their respective monetary policy strategy,” according to the report. The Fed’s “monetary policy decisions are, therefore, also conditional upon actual economic developments.”

The ECB and the Fed use guidance only to define their mandates, not to alter them, the Bundesbank said.

The ECB’s vague commitment has left investors unsure about the time frame of the central bank’s guidance. With the 17-nation economy emerging from its longest-ever recession in the second quarter, some economists suggest the ECB’s loose monetary policy stance might come to an end.

“Rate cuts are off the table for now,” Andreas Scheuerle, an economist at Dekabank in Frankfurt said last week.

While Draghi said on Aug 1 “forward guidance is valid until further notice,” other policy makers have offered different interpretations.

Executive board member Joerg Asmussen said in an interview with Reuters TV in July that “it is not six months, it is not 12, it goes beyond,” only to be corrected by an official clarification shortly afterward, with the ECB saying that no exact length for how long rates will remain low was given.

Executive board member Benoit Coeure told Bloomberg News on Jul 11 that the ECB will reassess its pledge every month.

“The additional information with regards to the monetary policy’s direction complements the previous communication,” the Bundesbank said yesterday.

“The goal is to explain the monetary policy stance in simpler terms so that as many market participants as possible can understand it.”

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