Stupid central banker tricks

July 5, 2011: 2:43 PM ET
The euro has rallied against the dollar despite worries about Greece as investors bet on ECB rate hikes.

The euro has rallied against the dollar despite worries about Greece as investors bet on ECB rate hikes. Click chart for more on currencies.

NEW YORK (CNNMoney) -- Greek debt crisis? What Greek debt crisis?

The European Central Bank is meeting this Thursday and is widely expected to raise interest rates by a quarter of a percentage point to 1.5%. That would be the second rate hike by the ECB this year.


Sure, the austerity vote in Greece is good news since it could mean the worst-case scenario fears about a euro meltdown may not be realized.

But this isn't the end to the difficulties in Greece. Doesn't it seem just a bit odd that the ECB is contemplating more tightening at a time when there are still legitimate worries about the problems spreading to Portugal, Ireland, Italy and Spain? Moody's downgraded Portugal's debt to junk status on Tuesday.

The sovereign debt woes could be disastrous news for banks in France and Germany -- the two big euro zone nations that actually have somewhat healthy economies.

But the ECB, unlike the Federal Reserve in the U.S., only has one mandate: inflation. (The Fed is charged with watching prices as well as employment.)

And even though commodity prices have come back from their peaks earlier this year, they are still somewhat alarmingly high. Crude oil, for example, has crept back above $95 a barrel. So that may be all that ECB president Jean-Claude Trichet needs to justify bumping rates up a bit.

Still, will the move backfire?

Another ECB rate hike would further widen the gap between interest rates in the euro zone and here in the United States. (They've been near zero since December 2008.) The general rule of thumb in the land of paper money is that the higher the interest rates are, the stronger the currency.

Europe cited as scariest risk to economy

But that's a problem from an inflation standpoint. With oil and many other commodities denominated in dollars, the weaker the greenback gets, the more likely it is for commodity prices to go higher.

"An ECB rate hike means a higher euro going forward," said Brian Gendreau, market strategist with Financial Network Investment Corp., a Segunda, Calif.-based advisory firm.

"It seems paradoxical that Europe, with its very serious problems, has a currency that's strong and rising but that's a reality. That means the trading bias is in favor of a lower dollar and higher oil prices," Gendreau added.

It makes you wonder if David Letterman needs to expand his stupid tricks franchise and create one specifically for central bankers.

Other currency experts wondered if the ECB should just leave well enough alone since crude prices have pulled back in the past few months after surging due to Arab Spring-inspired supply disruption fears.

"I don't think the ECB would be doing the right thing with a rate hike. Oil prices are high but inflation pressures have abated quite a bit," said Kathy Lien, director of currency research for foreign exchange brokerage GFT in Jersey City.

Lien said the ECB needs to pay more attention to slow growth in Europe -- even if it's not officially one of that central bank's particular mandates.

"Price stability is the top priority but the more important question is should the ECB be doing this during a fragile point of negotiations with Greece?" she said. "Raising rates makes financing more difficult for people in Europe."

What makes matters more vexing is the fact that it's not as if the ECB won't have other opportunities to raise rates soon if inflation does in fact pick up.

The ECB will meet again on August 4 and has another meeting scheduled for September 8. Wouldn't it be more judicious to wait for at least another month or two to see how the situation in Greece plays out before rushing to raise rates again?

"I am a little puzzled by why the ECB seems so intent on raising interest rates right now. It's not going to ease any of the problems in the peripheral euro countries," Gendreau said.

Still, some think that the ECB rate hike may be a non-event. That's because the euro has already rallied against the dollar this year despite all the negative headlines about Greece, Portugal, Ireland, etc.

"The speculation about a rate hike has been in the cards for a couple of months," said Ian Naismith, co-manager of The Currency Strategies Fund (FOREX), a Sarasota-Fla. Based mutual fund specializing in foreign exchange investments.

Naismith pointed out that just because the ECB is likely to raise rates on Thursday does not mean that this is the beginning of a long cycle of rate hikes. The key is going to be whether Trichet signals that he's still worried about inflation and that more rate increases are on the way.

"Nothing is etched in stone," Naismith said.

Let's hope so. The ECB does seem strangely hell bent on rate hikes even though Europe is still in the midst of major financial upheaval.

But the last thing Greece, other troubled European nations and the rest of the world for that matter, need is for the ECB to make matters worse with ill-timed policy decisions.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks. To top of page

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