Central banks face monetary policy dilemma

Both the European Central Bank and the Bank of England left interest rates unchanged yesterday. From Bloomberg:

European Central Bank President Jean- Claude Trichet indicated interest rates may be unchanged for months, saying that both inflation and the euro's advance against the dollar are cause for concern.

Speaking after the ECB left its benchmark interest rate at 4 percent today, Trichet said "brutal" currency moves are "never welcome," while the bank is "ready to counter upside risks to price stability." The European currency has risen almost 10 percent against the dollar since mid-August.

Trichet's stronger rhetoric, which he last used when the euro rallied in 2004, suggests the ECB is growing concerned that the currency's appreciation may undermine Europe's economic expansion. At the same time, surging oil prices are pushing up energy bills, adding to the ECB's inflation concerns. The Bank of England also left its benchmark rate unchanged today at 5.75 percent.

"Trichet is pretty much trapped," said Hans-Guenter Redeker, head of currency strategy in London at BNP Paribas SA. "You can have verbal intervention, but it has no effect if rates remain unchanged and the U.S. is cutting rates."

Trichet is not the only one who may be feeling trapped.

Fed Chairman Ben S. Bernanke said today the U.S. economy, the world's largest, is likely to "slow noticeably" this quarter while high commodity prices and a weaker dollar may stoke inflation "for a time."

If former Fed chief Alan Greenspan is right, "a time" may last for a quarter of a century.

Japan isn't facing high inflation but the Bank of Japan must feel trapped anyway, with yesterday's data likely delaying further interest rate normalisation. Again from Bloomberg:

The Economy Watchers index, a survey of barbers, shopkeepers and others who deal directly with consumers, declined for a seventh month to 41.5 from 42.9 in September, the Cabinet Office said today in Tokyo...

Merchants' views on prospects for business over the next two to three months also deteriorated. The outlook index slid to 43.1 last month from 46 in September, a sixth monthly drop.

Machinery orders, an indicator of corporate investment in the next three to six months, fell 7.6 percent in September from a month earlier, the Cabinet Office said today. That was five times more than the median estimate of economists.