The European markets fell for the consecutive third day on Wednesday after European Central Bank President Jean-Claude Trichet signaled that faster inflation will prevent policy makers from cutting interest rates to ease the continuing crunch in the credit markets.
Inflation risks are clearly oriented higher, Trichet told members of the European Parliament in Brussels, and the ECB was ready to counter such pressure, which it would normally do by raising interest rates. The ECB main interest rate currently stands at 4%. Eurozone inflation hit 3.1% in November, the highest level in six and a half years owing to rising costs of energy and food products. Trichet warned that "the period of temporarily high rates of inflation would be somewhat more protracted than previously expected." He added that another threat was posed by the possibility of other prices and wages increasing as a result, creating a so-called second round effect in the economy, as people were squeezed by higher consumer prices. "If we had second round effects then we would be in a totally different universe ... We will not tolerate second round effects," Trichet said, a clear warning that interest rates could increase if such an event occurred. "We will do whatever necessary to deliver price stability," he stressed, warning that any attempt to grant wage increases linked to the consumer price index would lay a foundation for more permanent long-term inflation. The ECB president was careful to direct his calls for moderation to those who set prices both for wages and products. "Our moderation message is not only for the social partners, it's (call for) moderation for all price setters." Meanwhile, Trichet drew a clear distinction between monetary policy as defined by its level of interest rates and operations on the money markets, where the bank has been exceptionally active in the past week. On Tuesday, the ECB made its biggest single injection of cash ever, providing almost 350 billion euros (500 billion dollars) for two weeks to help banks get through a crunch sparked by the collapse of the US subprime home loan market. The problem has been worst by the rising customer cash demands and book keeping requirements at the end of the year. "We are totally separating what we do as regards the monetary policy stance ... and what we do on the money market," Trichet stressed. On money markets, the bank focuses on "the shortest segment we can directly influence." Even as the ECB loans extra amounts of cash to banks for two weeks or three months, it carefully siphons off surplus liquidity in the very short term to avoid cash build-ups that could fuel inflation.