Contractionary Mania

The current bizaare mania for contractionary policies during a time of low inflation and economic weakness is not confined to the US, or to fiscal policy:

ECB signals eurozone interest rates are set to rise

The European Central Bank (ECB) has signalled that it will raise interest rates next month, from 1.25%.

Earlier on Thursday, the ECB kept rates unchanged for the second month in a row, after increasing them in April for the first time in almost two years. The central bank wants to raise rates again in July to curb inflation in some of the eurozone’s 17 member states.

However, one really has to squint to see any signs of an inflation problem in Europe. Commodity prices around the world (particularly oil and some raw agricultural products) experienced a bump in prices between the fall of 2010 and spring of 2011. But that is really the only source of inflation the Euro area has experienced recently, as the ECB itself admits, writing in their most recent Monthly Bulletin (pdf):

The increase in inflation rates during the first four months of 2011 largely reflects higher commodity prices.

Excluding energy and raw food prices, the core rate of inflation remains in the neighborhood of 1.5% over the past 12 month, well below the Euro-zone’s average inflation rate over the past decade. The following chart shows core inflation separately in Germany and in the rest of the core Euro-zone over the past decade.

Yet despite its acknowledgement that the recent rise in inflation is almost completely due to transitory factors (which began to reverse themselves in May), and without providing any reasoning for this statement, the ECB continued its discussion of inflation in the latest Monthly Bulletin by adding:

Looking ahead, inflation rates are likely to stay clearly above 2% over the coming months.

It’s hard to see how this will happen, when core inflation is well under 2% (which is by far the better predictor of future inflation — see this post by Paul Krugman for further details on that), this winter’s rise in commodity prices (that the ECB itself admits is the primary cause of the current bulge in headline inflation) is over, and in fact commodity prices have recently begun experiencing deflation as their prices fall back somewhat.

It’s mystifying.

• Become A Funded Futures Trader