ECB and rate tightening - QE at a price?

The ECB has taken the first step to control EU inflation by raising rates from 1 to 1.25 percent. This is the first time that the ECB has raised rates since 2008. ECB president Trichet, however, stated that monetary policy is still "very accommodative". The reason for the rate raise has been the increase in inflation above the 2% target set by the central ban. Many are perplexed by the increase given the sovereign debt crises and the fact that the inflation increase is loosely tied to food and energy costs. While Germany s doing well, many of the other euro countries are seeing a fragile recovery.

This action certainly is at odds with the views of Fed chairman Bernanke. It is seldom that the ECB will take the lead relative to the US central bank. Our take on the action is that it sends a signal to the market that the ECB wants to be viewed as an inflation fighter even though they are willing to provide a significant amount of liquidity. Their policy is quantitative easing at a price; nevertheless, the price is not high given that real rates are still below zero.