Eurozone Inflation Rebounds to Record Levels

Eurozone inflation has surged back to the record levels seen earlier this year, German data suggested on Wednesday, as soaring oil prices all but ruled out any early cut in European Central Bank interest rates.

Germany’s annual inflation rate leapt from 2.6 per cent in April to 3 per cent this month on a European harmonised basis, the country’s statistical office reported. Heating oil prices had risen by up to 13 per cent compared with April, and diesel by 9 per cent.

As a result, eurozone inflation has probably risen from 3.3 per cent to 3.6 per cent this month – the same as in March but otherwise the highest rate for almost 16 years. Official figures are released on Friday. Inflation could hit rates approaching 4 per cent in coming months, economists added.

Since the start of the global financial market crisis, the ECB has made clear that its interest rate policy would remain focused on controlling inflation. Next week, it will mark a year of keeping eurozone interest rates unchanged at 4 per cent.

Until recently, evidence that the eurozone economy was slowing – and decelerating dramatically in some countries, such as Spain – had been expected to lead to the bank following the US Federal Reserve and cutting interest rates later this year.

But the latest oil price surge has changed the interest rate outlook significantly. Earlier this week, Axel Weber, president of Germany’s Bundesbank, warned that an ECB interest rate increase was still possible, and financial markets have priced in a quarter percentage point rise by the end of the year.

Mr Weber is considered among the most hawkish” members of the ECB’s governing council, and most economists still think a rise in interest rates is unlikely. But the central bank is now expected to remain on hold for some time to come – possibly well into 2009.

The ECB has been careful not to send any clear signals on the likely direction of its next move. The central bank would talk tough about combating inflation dangers, but its hands are tied”, said Thomas Koch, economist at HSH Nordbank. With parts of the eurozone witnessing a sharp growth deceleration and higher oil prices also slowing economic activity, I find it very difficult to believe that the ECB would raise interest rates”.

The ECB aims to keep annual inflation rates below but close” to 2 per cent. Although central banks are powerless when it comes to controlling fuel prices, the ECB’s efforts are focused on preventing the current high headline rates becoming entrenched through higher wage settlements or other price changes.

Jean-Claude Trichet, ECB president, has long argued that expectations about future inflation rates should be kept firmly in line with the bank’s inflation goal. The ECB believes that has, so far, remained largely the case.

Eurozone Inflation Rebounds to Record Levels

Financial Times
5/28/2008 7:21:19 PM