Never slow to find an excuse to raise rates, this week the ECB started another rate-raising cycle with a 25bp increase to 1.25%.  Most other central banks on planet Earth agree that tightening monetary conditions to try to rein in inflation which has been pushed up by high oil prices will not work.  Why murder an economy when higher European interest rates will have little effect on an oil price which has been driven up by supply being curtailed by popular uprisings in the Arab world?  The ECB seems to have decided that rates have been at an “emergency” setting of 1% for far too long and they are keen to lift rates back up toward more normal levels even though there is a great big crisis going on in Europe’s peripheral sovereign debt markets which has every chance of causing the peripheral economies to slide into recessions.

Maybe part of the answer is that the ECB has been given the wrong mandate in simply requiring them to keep inflation under control.  It took years for the ECB even to formally tell the markets what it believed its inflation target was – only with the appointment of Jean-Claude Trichet did the phrase “below but close to 2%” become associated with the ECB’s inflation target.

The Fed and BoE have opt-out clauses built into their mandates.  In plain English the Fed’s job is to maximise growth & employment consistent with keeping inflation stable and the BoE is charged with keeping inflation close to 2% but without causing unnecessary recessions.

This is a reason why European equities should trade on lower valuations than either US or UK equities. Namely because every time the European economy shows signs of good growth, the inflation-obsessed ECB is going to spot signs of inflation creeping higher and jack rates up to squash inflation back down again.  Hence causing unnecessarily slow growth in Europe which serves to limit nominal GDP growth and by extension the profits of companies which do a lot of business in the euro-zone.  Central banks are supposed to take away the punchbowl just as the party gets going but the ECB seems to want to take the punchbowl away as soon as the first guest rings the doorbell!

The ECB has a track record of raising rates when trouble is already brewing (they raised rates in July 2008, only to have to start a rate-cutting cycle just three months later).  This time they are raising rates amidst a crisis in the sovereign debt of peripheral European countries.  Greece, Ireland, Portugal & Spain need low interest rates to help boost GDP, the last thing they need right now is monetary policy to be tightened.