The ECB’s Task: Make Everyone Happy

A surge in global commodity prices has led to widespread inflationary concerns among the biggest economic players. In the US, rising food and energy prices in particular have prompted economists to criticize the slow QE2 exit strategy employed by the Fed, clamoring for monetary tightening. In Europe, finance ministers share the same concerns; the only difference is, the ECB has another problem to tackle at the same time.

After receiving a hefty bailout, Greece looks like it will fall short of its budget deficit reduction goals. Meanwhile, Portugal just received the go-ahead for a 78 billion euro bailout fund from the IMF and EU. These battered economies (plus Ireland’s) will be especially sensitive to monetary tightening implemented by the ECB, leaving Jean-Claude Trichet and other head officials with a rather large predicament.

Perhaps there would be less on the line if the European Union hadn’t built such a proud reputation for routinely attacking inflation. Its dedication to keeping inflation down will now be tested as a hike in rates would make it increasingly difficult for Greece and Portugal to meet its debt obligations. It’s been recently declared that the Portuguese economy is officially in a recession.

One obvious problem is that the economies of the 17 EU countries are not as closely aligned as one would hope. While most of the Euro Zone has enjoyed sizable growth over the past twelve months, its periphery is in a world of hurt. This points to integration as being a goal for the EU in the future so that this mismatch in economic health becomes less pronounced.

The volatility in the euro/US dollar exchange rate should be off the charts this summer as the ECB deliberates on how quickly to raise rates. The next rate hike is believed to occur in July, but it’s not a certainty. Investors will keep a close eye on Italian financial mind Mario Draghi as he takes over as president of the ECB in October, and inherits this double-edged sword.

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