Some mandates, even if unstated, are more important than others. Officially the main concern of the European Central Bank is inflation. Unofficially its paramount goal is the survival of the euro and the EMU.

Unlike its American counterpart the ECB targets headline inflation, including food and energy prices, not the core metric which eliminate their volatile effects. Its stated goal is 2.0%. In December yearly CPI in the Euro zone came in at 2.2%, 0.3% higher than November and more than double the December 2009 0.9% measurement. Yearly PPI in December was 5.3%, 0.8% higher on the month and an astonishing 4.4%higher since March.

Until the financial crisis of late 2008 and 2009 the ECB was good to its inflation charge. In July 2008 only two months before the collapse of Lehman ushered in the acute phase of the crisis, the bank raised its main refinance rate 25 basis points to 4.25%. The Federal Reserve had been cutting the Fed Funds target for ten months at that point, having begun in September 2007.

Jena Claude Trichet, the ECB President has, over the past months made a point of repeating the bank's commitment to its inflation mandate. Even in the face of market disbelief that if the central bank was forced to choose between the low rates needed to support growth in the deficit ridden southern tier countries and the anti-inflation desires of the north, the president would be able to choose higher rates if inflation returned. Despite widespread doubts about the banks willingness to enact its purported anti-inflation policies Mr.Trichet had managed to keep the bank's anti-inflation credibility intact.

Until yesterday that is. When asked about price risks at the press conference following the rate announcement, Mr. Trichet said that risks are broadly balanced. EMU CPI movement is not balanced. The world is awash in liquidity. Commodity prices, pulled by demand and propped by speculation, are in many cases at record levels and showing no sign of fatigue. Recovery in the US and continued growth in China, India and the emerging world will keep commodity prices on the upswing. Inflation risks are assuredly not balanced.

In the United States the economic mandate of the Fed is explicit. The American central bank's promise of low rates as long as necessary is believed. The ECB prime directive for its own survival and the survival of the euro is not explicit. But to judge from yesterday's currency market reaction to Mr. Trichet's statement, a prompt one and a half figure fall in the euro, it is just as well understood.

Joseph Trevisani

Chief Market Analyst

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