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ECB Watch: One size doesn’t fit all. So what?

As recently as May this year, following the two 25 basis point increases of December 2005 and March 2006 that raised the European Central Bank’s main refinancing rate to 2.5%, ECB president Jean-Claude Trichet was speaking of the “still very low levels of nominal and real interest rates across the whole maturity spectrum”.

With three-month euro interest rates then just below 3% and 10-year government bond yields just above 4%, while headline inflation was running at 2.5%, it was hard to quibble with that. Five months and two more 25bp rate increases further on, in October, he said interest rates were “still low” and monetary policy “continues to be accommodative”. No “very” this time, no “nominal and real” and no “maturity spectrum” but hardly a wild claim with three-month rates at 3.5%, 10-year yields at 3.9% and inflation projections of 2.4% for this year and next. Think back six years, when inflation was 2.4% and the refi rate peaked at 4.75%.

But not everyone sees it quite like that. Despite these EMU-wide yardsticks, national inflation rates – and hence real interest rates – differ widely from country to country within the euro area. On average since the start of monetary union, the range between the highest and lowest three-month money market rates in real terms has averaged 320bp and the overall dispersion, measured as standard deviation, has averaged +/– 97bp, with no marked diminution over time. For those countries with the highest inflation rates, real interest rates have for long periods been negative, while in low-inflation countries they have been consistently positive.

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