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The ECB’s Honeymoon is Over

The honeymoon for the European Central Bank is over. Because European interest rates no longer are clearly out of whack with the fundamentals of the euro-zone economy, monetary policy has become more complex.

At the same time, France has given a strong mandate to its new president, Nicolas Sarkozy, who is without question the most formidable political adversary the ECB has had to face in its brief history. Sarkozy stands ready to pounce on any mistakes the Bank may make in this more difficult policy environment.

With European interest rates up 200 basis points since late 2005 and the euro near a record high, Sarkozy wants the ECB to stop raising rates now. ECB president Jean-Claude Trichet and the Governing Council strongly disagree.

At the ECB press conference in early July, Trichet signaled at least one more rate hike—either in September or October. Some Council members are known to support two more rate hikes before year-end.