Eurozone Inflation Rise Likely to Test ECB

Soaring inflation in the 13-nation eurozone is threatening fresh difficulties for the European Central Bank as it fights to calm tensions in financial markets that are casting a shadow over economic growth.

Energy and food prices pushed inflation in Germany this month to the highest level since at least 1995, prompting economists to forecast the annual eurozone figure, released today, will reach 3 per cent or more for the first time in more than six years. That would pose a serious challenge to the ECB, which pledges to keep inflation "below but close" to 2 per cent.

Jean-Claude Trichet, ECB president, said earlier this month that the inflation "hump" was proving larger and longer-lasting than expected. But the bank's room for manoeuvre on interest rates has been constrained by threats to growth from the euro's record strength and the global credit squeeze.

Analysts expect interest rates to hold steady at 4 per cent well into 2008, with some expecting a cut as the next move.

Yesterday the ECB pumped an extra €30bn ($44.4bn, £21bn) into money markets - far more than would have been usual in its regular weekly operations - following its pledge last week to keep up such emergency help until at least the end of the year.

Julian Callow, economist at Barclays Capital, said "the ECB is well and truly boxed in", with little scope for raising its main interest rate even though "the inflation hump is proving more of a hillock".

The ECB put further interest rate increases on hold in September, pledging first to assess the macro-economic impact of the credit squeeze.

French and German business confidence indicators yesterday showed unexpected rises for this month. The Munich-based Ifo institute said the rise in its business climate index, from 103.9 in October to 104.2, showed growth slowing only "gradually" from a high level. But the Ifo index had fallen in the six previous months, and ECB officials have struck a decidedly more pessimistic tone in recent days.

Lucas Papademos, ECB vice-president, warned on Monday of "an uncomfortable, though temporary, combination of higher inflation and somewhat slower economic growth in the coming months. Inflation risks and financial market volatility confront us with significant challenges". The global credit squeeze could prove "more protracted than previously expected", he added.

Revised ECB forecasts next week are likely to show average inflation next year higher than 2 per cent.

Eurozone Inflation Rise Likely to Test ECB

Financial Times
11/30/2007 6:51:07 AM