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Shadow ECB Council Sees ECB Stuck Between a Rock and a Hard Place

At the meeting of the Shadow ECB Council on 27 January there was unanimity to recommend that the ECB leave rates on hold despite a spike in inflation. There was near-unanimity in recommending that the ECB should not signal any intention to raise rates any time soon. However, the three members who had expressed a bias toward lower rates at the last meeting two months ago withdrew their bias, while one member now thinks that a rate hike might become advisable in the near future.

Members forecast higher inflation

Members? inflation forecasts for this year rose markedly from two months ago. On average, they now expect the year-average inflation rate to stand at two percent in 2011. For next year inflation is expected to be below the ECB?s benchmark again of "below but close to two percent". Growth expectations increased slightly, but growth is still expected to remain lacklustre at around one and a half percent or slightly above in the years 2010 to 2012.

Shadow Council Macroeconomic Forecasts

20101.7 %1.6%
20111.5 %2.0 %
20121,7 %1,8 %

Contributors:. M. Annunziata; M. Balmaseda; E. Bartsch; J. Cailloux; J. Callow; M. Diron, J. Henry, G. Horn, J. Krämer; T. Mayer; E. Nielsen; J.-M. Six

Assumptions: Forecasters assumed on average that the ECB would leave its key rate at 1% for the next six months.

No interest rate hike while financial sector is not stable

Many members of the Shadow Council are concerned that, if commodity prices rose further and inflation stayed above two percent, inflation expectations could become dislodged. Several members expressed concern that once rising inflation expectations led to high wage demands it could already be too late to intervene. However, these concerns are tempered for many by the high level of unused production capacities in the euro zone, which in their view significantly reduces the danger that imported inflation could morph into generalized domestic price pressures. These members argued that wage rises so far have been low. A significant acceleration of wage growth would be needed for them to become acutely concerned about a wage-price spiral.

Furthermore, most members would consider it unwise or even self-defeating for the ECB to raise rates while at the same time continuing to provide unlimited liquidity to banks. These members argued that flooding banks with liquidity was only needed and acceptable if the stability of the banking system as a whole was at stake. While this situation prevailed, it was argued, raising key interest rates would not make sense, as it would hurt the weakest banks the most. Members in this majority camp also considered it unlikely that a fragile financial sector could coexist with an economy that would be robust enough to allow for sustained inflationary pressure.

There was a strong consensus on the Shadow Council that it was incumbent upon governments to do more to recapitalize or liquidate troubled banks in order to take some of the burden off the ECB to use rate policy to secure the stability of the banking sector.

There was a widely held view on the Shadow Council that inflation pressure from imported commodities was not entirely "external", because the very loose monetary policies pursued in the US and other countries were an important factor in driving these prices up. However, consensus did not extend to the conclusions from this diagnosis. The majority considered it inappropriate for the ECB to try to counterbalance massive quantitative easing performed by the Federal Reserve in the US. Some, however, argued that each central bank had to do their part in resolving a global liquidity overhang, even if others did not.

Rate recommendation

There was unanimity that the ECB should not change interest rates at the next policy meeting on 3 February. One member expects a rate hike to become appropriate within the next three months to six months. All three members who still had a bias toward lower rates two months ago withdrew this bias.

Members' individual votes for 2 December

Jose AlzolaThe Observatory Groupno change
Marco Annunziata


no change
Elga Bartsch

Morgan Stanley

no change
Andrew BosomworthPimcono change
Manuel Balmaseda


no change
Jacques Cailloux


no change
Julian CallowBarclays Capitalno change
Marie DironOxford Economicsno change
Janet Henry


no change
Gustav HornIMK Macroeconomic Policy Instituteno change
Jörg Krämer


no change**
Thomas Mayer

Deutsche Bank

no change
Erik NielsenGoldman Sachsno change
Jean-Michel SixStandard & Poor\'sno change
Angel UbideTudorno change

**) Bias toward higher rates

Frankfurt 28 January 2011
Norbert Häring
Non-voting Chairman

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economists drawn from academia, financial institutions, consultancies and research institutes. The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a physical meeting). Its discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon.

Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitutes the panel's forecast consensus as published each month. The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinion about what the ECB should do, rather than what they forecast it to do (and hence the "normative" views as expressed by Shadow Council members on what they consider the ECB ought to do can and often do differ from what they might say they expect the ECB to do). This "normative perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council.

Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, though Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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