ECB warns that ‘inflation is never dead’

Date: 17/12/1998

By Renée Cordes

EUROPEAN Central Bank governing council member Yves Mersch believes rising property, stock and bond prices could spark faster inflation in the 11-country euro zone next year.

"For the moment, inflationary pressures do not seem to give rise to excessive concern," Mersch told European Voice as he prepared for the council's last meeting next Tuesday (22 December) before monetary union begins. Nevertheless, warned the president of the Luxembourg Central Bank, "inflation is never dead."

Today's subdued price climate, he argues, is the result of specific factors such as low energy prices and could be threatened by the seemingly inexorable rise of asset prices. "If you look at growth rates in certain asset prices and you compare it to the savings rates, one could ask oneself certain questions," he said. "This is one element that we have to keep under review."

Prices in the euro area rose by 1.0% in the year to October, well within the ECB's inflation target of 0-2%. ECB President Wim Duisenberg recently forecast that inflation would accelerate to 1.6% next year.

At the same time, says Mersch, Europe's economies could also take more of a beating than previously thought from the trickle-down effects of the Asian financial crisis. "I think that the biggest danger of the crisis situation outside Europe is that European business confidence will be dramatically affected," he said.

Mersch also warned of "contagious effects" from Japanese deflation, although he said this was not a serious concern yet.

The European Commission's latest forecasts suggest euro-11 gross domestic product will grow by 2.6% next year rather than by the 3.2% it had earlier predicted, asrecession-hit Asia, Latin America and Russia cut back on their purchases of EU exports.

Mersch says one of the driving forces behind this month's pan-European interest rate cut was a desire to boost confidence before the single currency is launched in January.

Two weeks ago, France and Germany cut their key interest rates by 0.3 of a percentage point to 3%. Other euro-11 countries followed suit within minutes, with cuts of up to 0.75 of a percentage point. Only Bank of Italy Governor Antonio Fazio held his fire, cutting rates by 0.5 percentage points to 3.5%.

The move stunned the financial markets, which had been anticipating a rate cut within the first three months of next year.

Mersch says the ECB governing council decided on the rate cut at its meeting two days earlier simply to get it out of the way before economic and monetary union began on 1 January. He argues that the decision to ease monetary policy before the euro appears should provide "the necessary serenity" for the bank to concentrate on its basic money market operations.

Mersch denies that money supply targeting lost its value as a policy tool when the ECB opted for a 'reference value' rather than a straightforward target. The council has set a value for broad M3 money supply, which includes cash and short-term bank deposits, of 4.5% for 1999.

"It has never been downgraded because it has never existed at European level," he insisted, emphasising that the ECB's 17-member board would look at several indicators, including money supply, when setting monetary policy.

"Money is still the business of central banking, but central bankers must not be blind to other signals and should use all the instruments that are at their disposal," he added, stressing that a reference value only meant that it would be up to the bank to decide how to respond to changing economic conditions.

While the ECB will also look at exchange rates, Mersch denies that it has an unofficial exchange-rate target. "For an area like the euro area, it would be inappropriate to have an exchange-rate target but, of course, the exchange rate is another element that has to be taken into consideration because of its consequences on the level of prices. From that point of view, it is not something that we would simply disregard," he said.

The dollar has lost about 7% of its value against the deutschemark since the start of the year, but Mersch insists that the current exchange rate between euro-11 currencies and the dollar is "not giving rise to concern".

The Luxembourg central banker, a long-serving member of the EU's influential monetary committee, also rejects suggestions that the euro-zone will not be able to speak with one voice in international fora, given that it will be represented by the ECB president, ministers and central bankers from Germany, France and Italy, and the holder of the rolling presidency of the euro-11 ministerial coordinating group.

However, he does acknowledge that while US Federal Reserve Chairman Alan Greenspan has a euroland counterpart in Wim Duisenberg, there is no European equivalent to US Treasury Secretary Robert Rubin. That too, according to Mersch, will eventually have to change. "I think over time there will be a properly working arrangement, but don't underestimate where we come from," he said, pointing out that Europe had a long history of smaller states holding the power of larger states in check - a balance which has worked well until now.

The same is true within the ECB's governing council, according to the Luxembourger, who stresses that its members are not there to represent the interests of individual countries.

"I don't feel put under pressure by anyone on the board and I don't think anyone has been put under pressure," he said.

"What is important is that we sing in the same choir without too much dissonance."

Interview with ECB governing Council member Yves Mersch.