Monetary policy has been described as taking away the punch bowl just before the party gets going. Yesterday, the European Central Bank (ECB) put up interest rates by one-quarter of a percentage point. In communicating the reasons for its action, ECB president Jean-Claude Trichet said that the stance on monetary policy needed to be adjusted to keep inflation low. Put simply, he and his colleagues see present interest rates as too low to secure price stability.
The three key questions for any monetary policy decision are: whether to raise or lower rates, by how much and when? On the first question, there is little doubt that the next interest rate move needed to be upwards. Yesterday's decision draws to a close a period of 2½ years during which interest rates have remained at levels that are historically low and accounting for inflation, actually negative in some euro zone countries.
In relation to the second question, the extent of rate increases will be more modest than before. Between 1999 and 2000, the ECB put up interest rates by 2.25 percentage points over an 18-month period. Explaining yesterday's decision, Mr Trichet dispelled fears of a repeat performance. He made it clear that, by raising rates, the ECB was not pre-committing itself to a programme of future, staggered rate increases.
Europe is not growing as robustly now as was the case in 1999 and 2000. Inflationary pressures are threatening. But they are related to the rising long-term demand for oil and commodities by China and India and they do not require the same speed of reaction. Any further increases next year - if they come - are likely to leave rates no more than 1 percentage point higher at the end of 2006 than they were yesterday morning.
A question remains as to whether the ECB needed to begin increasing rates at this time. Has the party really started in the euro zone? Opposition has come this week from prominent academics who have argued that recovery in France, Germany and Italy is too fragile to risk raising rates. They were joined on Tuesday by Brian Cowen and his fellow EU finance ministers. But Ireland can withstand a one-quarter percentage point increase. Besides, in his Budget next week, Mr Cowen will put back far more into the economy than the very modest amount taken out of it by the ECB yesterday.
If anything, the rate increases are a blessing in disguise. Whatever about Europe, the party is not only under way in Ireland, but threatening to get out of hand. Central Bank statistics released on Wednesday show that lending growth is gathering pace to run at almost 30 per cent per annum, and further data shows that house price growth is accelerating again after slowing earlier this year. Yet more data released this week shows that employment growth continues to surge. With SSIAs injecting further impetus to the economy next year, modest interest rate rises may have a welcome cooling effect on inflation here.