The European Central Bank decided yesterday to increase its key interest rates by 25 basis points to 1.25%, starting a cycle very likely to continue further over 1.5% this year. Whatever happens in Southern Europe and however it is going to impact less competitive economies of EMU, the ECB is fighting a wrong enemy.

In times of rising energy and food prices, the ECB tries to tackle a non-existent problem. The 2.6% inflation has no potential to trigger an inflationary spiral in the context of budgetary austerity and salary moderation.

It is only going to inhibit rising commodity prices by impacting more severely than by its marginal change (0.25% to the date) the price of money in real economy, rates of investment and consumption of the Eurozone and of countries of its neighbourhood that have central banks with de facto no or little monetary lever to maintain their sovereign interest rates (including the Bank of England).

Whatever we think about the appropriateness of the 2% target, the current and further future increases of the key interest rate are going to strengthen the common currency (as it was the case after the announcement itself), although it has all interests to remain weak in next quarters, especially considering effects of the American quantitative easing and Chinese systematic exchange-rate manipulation (disregarding rise of its own intervention rate).

So why, for Trichet’s sake, are they doing it?

Firstly, were it Bundesbank, interest rates would have been probably raised earlier this year and might have never plummeted so low. The ECB is not Bundesbank though and has to take into account business cycles all over Europe. Economic growth is far from returning to normal in recent quarters, particularly if shadows of further short-term economic slowdown emerged with rising energy prices (for geopolitical, not demand-driven reasons). One-size-fits-all policy is a bad policy, it is better though than a one-size-fits-Germany policy. By raising interest rates right now, the ECB is opting for the latter interpreting it falsely as the former.

Secondly, money may be too cheap, building up for a new overheating of economy and potential bubbles. With growth at about 0.3% in last two quarters of 2010 and projected 1.7% growth both for 2011 and 2012 (!), overheating is however more a wish than a threat and if defaults and haircuts are inevitable with current debts already too high, 25 bips are not going to change anything, in contrary, it’s going to increase the debt burden through more need for refinancement, not motivate countries to borrow less. Moreover, bursting bubbles just after crisis should be regulators’ job, not central banks’ one, as it would threaten the whole economy, not just the bubbling sectors.

Thirdly, some economists and businessmen are keen to mark the end of the crisis. The yesterday’s decision might thus have been more symbolical than economic or monetary. Sending a good message might be a good strategy. Who knows however, how markets are going to interpret it? It may very well be the very opposite way. A very small sign of weakness in next weeks could feed reasons for a negative rather than positive interpretation of the message.

In overall, none of the three reasons justify the threat that higher interest rates would present to the Eurozone and competitiveness of its weaker members.

A lost decade

Inflation is not a Satan that we have to avoid in all circumstances and the 2%-inflation target is far from being an ultimate de facto goal of the ECB. Tightening money supply too early after a crisis with raising issues of uncompetitiveness is though clearly harmful.

Let us pray to gods of the world economy that ECB’s Governing Council’s yesterday decision does not mark a start of a lost decade for the European economy. It does mark it for Greece already.

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Used figures come from the Economist Intelligence Unit, ECB’s official-data releases, and FT.