The European Central Bank's quarter point interest rate increase has been called 'counter-productive,' 'unnecessary,' even 'self-defeating.'

All of which begs the question, why did the ECB last Thursday increase interest rates so soon? (The ECB increased its key interest rate, the refinance rate, a quarter point to 4.25%, last Thursday.)

One argument is euro zone inflation, presently running at about a 3.7% annualized rate. That's well above the ECB's 2% inflation limit.

Another day, another oil record.

Oil easily pushed past $145 Thursday morning after traders calculated that the already weak dollar has further to fall after the European Central Bank increased a key interest rate by a quarter point to 4.25%.

Oil rose as much as $2.28 to $145.85 per barrel -- an all-time high -- before easing back slightly to trade at $144.40 at mid-day.

Oil tends to rise when the dollar falls as investors/traders seek to preserve purchasing power of the decreased value of dollar-denominated commodities by bidding their price up. However, it's important to note that the dollar/oil correlation is not perfect: there have been instances in which the dollar fell and oil fell.

These days, European Central Bank President Jean-Claude Trichet isn't too popular in currency market circles, if one trader is any indication.

Trichet, a legendary inflation hawk, campaigned for and secured a quarter-point interest rate increase Thursday, to 4.25%, in the ECB's key, short-term interest rate, the refinance rate. Many economists thought Trichet's action was premature, despite Europe's 3.7% annualized inflation rate, and that it could spell further economic slowing Europe. Unbowed, Trichet plowed ahead.

With the above as a backdrop, many currency traders, Andrew Resnick among them, plowed ahead with euro-long trades on the calculation that a higher interest rate for the euro will cause the euro to rise. Resnick went long with the euro in the euro-dollar currency pairing.

But then what did Trichet do? He stated at the regular post-ECB rate decision press conference that he has "no bias" and that "we have no pre-commitment" to raise rates further - - signaling that one interest rate increase may be enough, Bloomberg News reported.

The result? The euro plunged versus the dollar after his comments: it fell 1.2 cents - - a large price move in the currency market - - to $1.5758 Thursday morning.

And with it plunged Resnick's profits for the day. All his trades were stopped-out for losses.

'Trichet is making many friends among traders'

"Trichet," Resnick said, "isn't making many friends among traders, and probably not among business executives and economists as well." Resnick followed his evaluation of Trichet's social standing with several candid and frank, descriptive, colorful comments about the ECB president that can't be published here. Suffice it to say that Resnick is not happy with Trichet's two-step.

In a move that surprised almost no one, the European Central Bank increased its key interest rate, the refinance rate, a quarter point to 4.25%. The increase brings the refinance rate to its highest level in seven years.

The currency market, which for the most part had already factored-in the ECB rate increase, did not react initially following the decision. The euro was virtually unchanged versus the dollar at $1.5882.

The other major currency pairings also held their ground. The dollar was unchanged against the pound at $1.9884 and the dollar rose slightly, up 0.10 yen to 106.25 yen, versus Japan's yen.

Economist: Trichet 'jumped the gun'

London-based economist Mark Chandler told BloggingStocks Thursday the ECB's decision was no surprise, but that doesn't decrease his disappointment with the ECB's stance.

"I afraid I'm going to really disagree with this one. I understand where [ECB President Jean-Claude] Trichet is coming from, but he's jumped the gun from my perspective. He could have waited another quarter," Chandler said. "There's a real concern now he's going to throw Europe into a recession like America, and if the dollar continues to fall against the euro, his rate increase won't lower inflation all that much. I don't like that bargain at all."

Let's just say that if the Dow Jones Industrial Average on Thursday closes down 200 points, we'll call it a moral victory. The Dow Wednesday closed down 166.75 points to 11,215.75.

"What was that famous Bette Davis line about a bumpy night? Well, Thursday could be a bumpy day," economist Peter Dawson told BloggingStocks Wednesday.

Thursday could be very bumpy for the stock market because a series of data points -- all expected to be negative -- are converging at a traditionally difficult time of the year for the market - the start of summer.

Three data points of significance

First up is the European Central Bank's interest rate decision at 7:45 a.m. EDT, at which the bank is expected to increase its key, short-term interest rate, the refinance rate, by a quarter-point to 4.25%. The ECB is trying to check inflation, Dawson said, but it may end up hurting the dollar. If the markets believe the already-weak dollar will fall further, that will increase commodity prices, including oil, "which will not be good news for stocks," he said.

The worst news Wednesday regarding oil wasn't its record high close of $143.57 per barrel. It was the dollar.

"There may be another record Thursday, and another Monday, and so on," energy trader Jim Dietz told BloggingStocks Wednesday.

The reason? Concern that the already weak dollar will fall further, Dietz said. The European Central Bank meets Thursday to vote on interest rates, with many economists expecting the ECB to increase it refinance rate by 25 basis points to 4.25%. If it does, the dollar may fall further, Dietz said.

Traders eye ECB meeting

"And if the dollar falls, that would put even more upward pressure on oil, so all eyes will be on that ECB decision," Dietz said. The ECB will announce its decision Thursday at 7:45 a.m. EDT. Oil tends to rise when the dollar falls, as investors / traders seek to preserve purchasing power of the decreased value of dollar-denominated commodities by bidding their price up. However, it's important to note that the dollar / oil correlation is not perfect: there have been instances in which the dollar fell and oil fell. Thursday won't be one of those instances, Dietz said.

"If we see a major move down by the dollar, say one cent against the euro, that will easily send us over $145 a barrel," Dietz said. As of late Wednesday afternoon, the dollar had already fallen about nine-tenths of a cent to $1.5882 versus the euro.

In comments made June 23 to Germany's Die Zeit but published only today, European Central President Jean-Claude Trichet warned of an "explosion" in inflation if the bank does not act decisively to counter it, Reuters reported Wednesday.

"If we are not resolute, there is a risk that inflation will explode. If we act decisively, then we can master the situation," Trichet said in the German text of comments published by weekly Die Zeit on Wednesday.

Trichet's comments appear one day before the ECB's meeting on interest rates. Many economists expect the ECB to increase its key interest rate, the refinance rate, by 25 basis points to 4.25%. (The ECB decision will be announced Thursday at 7:45 a.m. EDT.)

At issue: How to check inflation

European inflation is running at a 3.7% annualized rate, and trending up. That fact, combined with Trichet's comments published Wednesday, "all but guarantee a rate hike Thursday by the ECB," in economist David H. Wang's interpretation.

It's a European anti-inflation campaign that will require boldness, creativity, and patience.

That was how one economist described a potential monetary policy tack by the European Central Bank (ECB) for the quarters ahead.

London-based economist Mark Chandler told BloggingStocks that typically, a central bank will increase interest rates to fight inflation. Paradoxically, he's not recommending that the ECB do that now.

"It is a bit of a paradox, but if the ECB raises interest rates it may have the effect of, in fact, increasing inflation," Chandler said. (Euro-zone inflation is presently running at about a 3.7% annualized rate -- well above the ECB 2.0% limit, according to Eurostat.)

Contain commodities prices, contain inflation

Here's how an interest rate hike may hurt inflation's cause: a rate hike would put the euro, once again, in a superior investment position versus the U.S. dollar, causing the already-weak dollar to fall more, Chandler said. As the dollar continues to fall, commodity prices -- including oil -- will continue to rise, as investors seek to preserve purchasing power of the decreased value of dollar-denominated commodities, and as a general inflation hedge.

The European Central Bank's president has 'clarified' earlier comments on the continent's monetary policy by stating that interest rates may, or may not, rise in the months ahead.

"I said that we could increase rates by a small amount in order to secure a solid anchoring of inflation expectations,"' ECB President Jean-Claude Trichet told the European Parliament in Brussels Wednesday, Bloomberg News reported. "I didn't say that we could envisage a series of increases. That being said, of course we never pre-commit."'

Earlier this month, on June 5, Trichet said the ECB might raise its key short-term interest rate, the refinance rate, by 25 basis points, to 4.25% in July to contain rising inflation in Europe. Inflation is currently running at a 3.7% annual pace, according to Eurostat, the European Union's economic statistics office, well above the ECB's 2% limit. (pdf)

Trichet dispels multi-hike chatter

During his July 5 comments Trichet did not rule out multiple interest rate increases, which the currency markets interpreted as a signal that at least one interest rate increase was ahead, possibly more, and the markets bid-up the price of the euro. On Wednesday, Trichet sought to dispel that notion, while at the same time letting the markets know that no rate decision has been made.

Still, the euro rose about one-half cent against the dollar Wednesday to $1.5645, although it should be noted that the currency markets were also responding to anticipated stand-pat stance on interest rates by the U.S. Federal Reserve. And this afternoon, the Fed, as expected, kept its key, short-term interest rate the same at 2%, while also saying the balance of risks had shift to inflation containment from slowing economic growth / economic recession.

The dollar is on-pace to record a large weekly decline Friday -- undoing last week's gains against the euro and pound -- as traders and analysts debated the likely next step for the U.S. Federal Reserve and European Central Bank.

The dollar traded at about $1.5637 to the euro Friday at mid-day, which would represent a 3-cent decline for the week, if it maintains that level by the New York close at 5 p.m. The dollar also traded at $1.9760 to the British pound, also about a 3-cent loss for the week.

Currency trader Andrew Resnick told BloggingStocks Friday concerns about rising inflation in Germany and financial service losses in the United States have caused a sentiment adjustment in the often-volatile currency markets.

A shift in sentiment

"Last week, the debate was structured around rising inflation in the U.S. and how long the Federal Reserve could hold-off before raising interest rates. That was bullish for the dollar," Resnick said. "But this week we've seen a reversal. The talk now is about [European Central Bank President Jean-Claude] Trichet beating [Fed Chairman Ben] Bernanke to the punch on interest rates, and that put a lot of traders in euro-buy mode." Resnick added that he is presently flat, or has no open currency trading positions.

Notch yet another data point in the monetary policy tightening camp.

Inflation in the euro-zone accelerated in May to a 3.7% annualized rate, as surging fuel, food, housing forced up costs across the 15-nation currency area, Eurostat, the European Union's economic statistics agency, announced Monday. (pdf)

Further, euro-zone inflation is now running at its highest rate since 1996. Inflation had increased at a 3.3% annualized rate in April, Eurostat said. Food prices and transportation prices, up 6.4% and 5.9%, respectively, in the past year, were major factors in inflation's rise.

Currency traders responded to the inflation news by bidding up the euro and short-circuiting - - at least for the time being - - a recovery in the dollar. The euro gained about 1 cent to $1.5483 versus the dollar in Monday afternoon trading.

Trans-Atlantic two-step

London-based economist Mark Chandler told BloggingStocks Monday the May euro-zone inflation data is another debating point for the inflation hawks on the European Central Bank. "Even before the latest data everyone had pretty much discounted that [ECG President Jean-Claude] Trichet wants and is going to get a rate increase. But now there's concern there may be more than one rate increase ahead. The currency markets certainly reflected that," Chandler said. "It's a bit premature to start talking about multiple rate hikes, in my view."

The dollar Friday was poised to record its largest weekly gain versus the euro in three years, on a growing consensus that the U.S. Federal Reserve will increase interest rates soon to check rising U.S. inflation.

The dollar traded up about one-half cent to $1.5372 versus the euro early Friday afternoon - - a level that if sustained at the New York close at 5 p.m. EDT would give the greenback its biggest weekly gain since early 2005, Bloomberg News reported Friday.

The dollar also rose Friday against the other major currencies. The dollar increased about one-half cent to $1.9494 versus the British pound, and about sixth-tenths of a cent to $1.0476 versus the Swiss franc. The dollar was unchanged versus Japan's yen at 107.90 yen.

It goes without saying that central bankers can alter economic sentiment in a hurry.

Confidence in the global economy declined in June as central bankers signaled they may be ready to increase interest rates, a new Bloomberg survey indicated Wednesday. The Bloomberg Professional Global Confidence Index fell to 21 in June from 22.7 in May, with respondents more pessimistic in every region. A reading below 50 indicates negative sentiment.

Economists, investors, and traders need not look much farther than the newspaper (or web site) headlines to confirm their worst fears regarding the likely track for interest rates. Last week, the notoriously-hawkish European Central Bank President Jean-Claude Trichet became notoriously clear: he said the ECB could possibly increase interest rates as early as its next meeting to check the continent's inflation rate, which like the U.S.'s, is rising due to sky-high oil prices, The Economic Times reported.

Then on Monday, U.S. Federal Reserve Chairman Ben Bernanke said he'll "strongly resist" any increase in inflation expectations, Reuters reported.

Ahead: Rate hike or hikes?

Economist Peter Dawson told BloggingStocks Wednesday it's clear interest rates are headed higher up ahead, but he's hoping the central bankers aren't acting too soon.

To paraphrase Mark Twain, if you don't like the monetary policy climate in the world's major economies, wait awhile.
Monetary policy, historically the super oil tankers of the international finance world -- slow to get in motion, with only gradual course adjustments -- have in recent times approximated quicker responses typically found elsewhere in the markets.

Up until about a week ago, the mantra was lower interest rates, liquidity to guard against the credit squeeze/crisis, with a bias toward stimulating economic growth. For example, economists and analysts generally expected the European Central Bank to (finally) lower its benchmark, short-term interest rate to stimulate the euro-zone's slowing economy.

But then last week the notoriously hawkish ECB President Jean-Claude Trichet became notoriously overt: he said the ECB would likely increase interest rates at its next meeting to check the continent's inflation rate, which like the U.S.'s, is rising due to sky-high oil prices.

Then on Monday, U.S. Federal Reserve Chairman Ben Bernanke said he'll "strongly resist" any increase in inflation expectations, Bloomberg News reported. The markets interpreted Bernanke's comments as a sign the Fed will seek to both quell inflation and limit a further decline in the dollar -- the latter itself a source of rising commodity costs and inflation. Bernanke's comments caused the dollar to strengthen Monday against the world's other major currencies -- a strengthening that continued through Tuesday afternoon. (Still, traders are reluctant to declare it a dollar rally, given the dollar's many, prior, false break-outs.)

In the final analysis, the European Central Bank may not attend the Fed's rate cut party, after all.

ECB President Jean-Claude Trichet said Thursday the ECB may increase interest rates as soon as next month to check euro-zone inflation, Bloomberg News reported Friday.

On Thursday, the ECB kept its key, short-term interest rate at 4%. That pause, combined with the U.S. Federal Reserve's rate cut pause, suggests that the world's two strongest central banks believe there may be enough monetary stimulus in the system to avert a regional recession prompted by the worst housing slump in the United States in more than 15 years.

Trichet: the hawk of hawks

The Fed has cut short-term interest rates by 325 basis points to 2% since September 2007. Further, while some economists had forecast a mild ECB easing in mid-2008 to stimulate euro-zone growth and avert a regional recession, throughout the Fed's easing cycle Trichet has maintained his notoriously hawkish stance and has repeatedly underscored the need to check oil-fed inflation in Europe.

Inflation is running about at 3.1% annual rate in the euro-zone, and May data indicated inflation continues to trend higher. Trichet's Thursday comments represent the most specific signal to-date from the ECB that the bank's bias concerns checking inflation, not stimulating growth, given its read on economic conditions.

Economic Analysis: Trichet's stance is not surprising, but in this case he may be hitting the monetary policy brake too soon. The legendary inflation hawk would dearly love to get out of this economic slowdown without an interest rate cut, but it may not be possible. Economic growth in the euro-zone's border economies is slowing, while the U.S. economy is barely showing a pulse. If the euro-zone falls into a recession, Trichet's hawkish stance will be viewed as a needless -- and avoidable -- monetary policy error.