The Euro soared in conjunctions with a “successful” auction on Portugal (about 3.5% higher than German 10-Year Bonds) followed by comments from Trichet about rate hikes when the Euro was in a strenuously oversold condition.

Crashes come from oversold conditions, not overbought ones, and central bankers are well aware of it. Trichet got the reaction he wanted, now he attempts to “fine tune” investor expectations.

Please consider ECB Officials Retreat From Threat of Higher Rates

“The Governing Council of the ECB sees present interest rates as adequate,” council member Ewald Nowotny said at an event in Budapest yesterday. “We do not see a need for an interest rate change in the foreseeable future.” Bundesbank President Axel Weber also said he expects inflation to remain below the ECB’s 2 percent limit in the medium term, softening his language on the risks to price stability.

“It looks like the ECB is now trying to fine-tune market expectations,” said Laurent Bilke, global head of inflation strategy at Nomura International in London, who used to work as a forecaster at the ECB. “The market didn’t get the ECB completely right, but at the same time policy makers will not be successful in telling the market that there hasn’t been a shift in the policy stance.”

The euro has risen five cents against the dollar since ECB President Jean-Claude Trichet last week warned that the central bank will act if needed to contain inflation risks, which he said “could move to the upside.” Nowotny joins Athanasios Orphanides of Cyprus in suggesting markets may have over-reacted to the comments.

‘One-Sided’ Interpretation

“I think the statements of President Trichet at the last press conference have been perhaps interpreted in a rather one- sided way,” Nowotny said. Orphanides said in an interview published on Jan. 17 that the ECB’s policy statement was not “overly hawkish” and there is sometimes an “overreaction to the underlying message.”

ECB officials “are trying to dampen rate expectations that have increased after Trichet’s comments,” said Jacques Cailloux, chief European economist at Royal Bank of Scotland Group Plc in London. “The market did overreact.”

A stronger currency could undermine European exports just as the euro region grapples with a sovereign debt crisis that’s forced governments to cut spending, damping the outlook for economic growth. Higher ECB rates would also increase the burden on debt-strapped nations. The central bank has held its benchmark interest rate at a record low of 1 percent since May 2009.

Weber said in a speech in Frankfurt yesterday that while inflation risks “could increase,” they are still “more or less balanced” and prices should remain contained in the medium term. Last week, he said risks to the medium-term inflation outlook “could well move to the upside.”

The euro surged after on the comments and Citigroup Inc. immediately revised its forecast for the ECB’s first rate increase to the second half of this year from the first quarter of 2012.

Trichet Has No Credibility

Trichet has violated everything he has ever stood for when he bought sovereign debt and allowed Ireland to print money backed by absolutely no collateral at all (see ECB Allows Irish Central Bank to Counterfeit 51 Billion Euros).

So how can Trichet be believed? For that matter, why should anyone believe Citigroup’s analysts either?

Judging from the reaction and the recent comments by Trichet, it appears he wants an orderly decline in the Euro to help exports much the same the US wants an orderly decline in the dollar, Brazil wants an orderly decline in the Real, and every country on the planet wants an orderly decline in their currency as well, all so that everybody can increase exports. Mathematically it does not work, and never did.

Trichet did manage to buy time, and that is always one immediate goal of every central banker.

Mike “Mish” Shedlock
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