Trichet Holds His Hawkish Tone Despite Ongoing Financial Turmoil

Less than an hour after the European Central Bank announced the benchmark rate would be held at 4.00 percent, President Jean Claude Trichet delivered his usual commentary to an attentive public. Over the past few weeks, speculation that the policy authority would take a more dovish approach to its rate decisions had grown after a number of leading indicators have shown a stunting in the region's strong pace of economic growth and data that suggests inflation trends are finally pulling back to tolerable levels.

Just yesterday, a report of consumer spending revealed Euro-Zone retail sales plunged 1.6 percent in the year through March - the sharpest decline on records going back to 1995. More importantly, for the inflation-minded policy board, the leading annualized German CPI number unexpectedly dropped from a 3.1 percent to 2.4 percent clip, which was both a 10-month low and much closer to the central bank's 2.0 percent target.

However, despite these dovish shifts in economic data, President Trichet did not waver in his hawkish stand. Highlighting the group's primary concern for the future of policy action, the central banker said that upside risks to inflation were prevailing and that price pressures would remain their "highest priority." Furthermore, Trichet stated that in attempting to avoid second round inflation effects, he was concerned about the short to medium-term effects of rising food and energy prices. What's more, he suggested he was also worried about the strong pricing power that firms have had and attempts to index wage growth - both factors that easily send inflation into an upward spiral. Looking outside of his inflation concerns, even his gauge of economic growth and the health of the financial markets was hawkish on balance. While the President said their were downside risks to growth, he still read moderate, ongoing growth in data. Altogether, he confirmed his belief the economy would meet the ECB's forecasts for 2008 growth. One possible caveat to stable growth though was financial market turmoil. At the same time, after mentioning this factor as the main downside risk to the economy going forward, he went on to say that he saw little constraint in lending and tha tmoney and credit growth were "still vigorous."

Altogether, the ECB's hawkishness was not unexpected; but the optimistic view for economic growth amid the global downturn and ongoing credit crunch was not fully factored into the market. And, while there were comments that suggested the group would not lift rates in the foreseeable future, they are still far more hawkish than their American, British and Canadian counterparts. With rate forecasts showing little sign of yielding, the fundamental strength of the euro may weather otherwise significant declines in future economic indicators.

DailyFX

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