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ECB has to fight inflation

ECB has to fight inflation

FRANKFURT, April 17 (Reuters) – The European Central Bank has to actively fight the risk of spiralling wages and prices and ensure interest rates are high enough to curb inflation, German Bundesbank President Axel Weber said on Thursday.
Weber’s deep concern that the ECB does not let current record inflation become a long-term trend reflects similar remarks by Executive Board member Juergen Stark on Tuesday and Cyprus central bank chief Athanasios Orphanides on Thursday.
“Recent wage dynamics in conjunction with elevated and persistent energy and food price pressures have increased the risk of a prolonged period of intolerably high inflation,” the German Bundesbank president told the British Chamber of Commerce in Frankfurt.
The ECB’s staff would take this into account when they revised their inflation outlook in June, Weber said. Inflation was unlikely to fall much below 3 percent until the last two months of 2008, and remain well above 2 percent in 2009.
The ECB aims to keep inflation just below 2 percent over the medium term, but in March — when inflation hit a record 3.6 percent — its staff forecast inflation to average 2.9 percent this year and 2.1 percent in 2009.
Weber was more optimistic about the prospects for financial markets and the euro zone economy. Though markets faced more pain, the worst was probably over, and euro zone growth was unlikely to be hurt as much by the U.S. economic slowdown compared to previous downturns, he said.
The ECB has kept rates on hold at 4 percent since the start of the U.S. subprime mortgage crisis last summer, and in recent weeks the inflation outlook has increasingly caused economists to write off the chances of an ECB rate cut this year.
Weber said it was essential the ECB did not allow higher food and energy costs to feed into other wages and prices.
“Given the costs of curbing such inflation dynamics once they have started, the stability-oriented Eurosystem has to fight the risk of broad-based second-round effects decisively and proactively,” Weber said in a text from the Bundesbank.
“Against this background, we will have to continuously monitor closely all incoming data and evaluate whether the current level of interest rates in fact ensures achieving our objective,” he said.
Last week Weber ruled out cutting rates, and Stark said at the European Parliament on Tuesday that the ECB had to be ready to act decisively to quash second-round effects.
“These are the first remarks which bring out clear concern about wage deals. I don’t think it suggests a rate hike debate, but you wouldn’t want to mention a rate cut to Mr Weber for a while,” said Holger Schmieding, economist at Bank of America.
“A rate cut this year is unlikely but I still think the ECB is too optimistic for growth,” he added.

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FX REACTION
The ECB’s close focus on inflation contrasts with that of the U.S. Federal Reserve, which has cut rates by 3 percentage points since the start of the subprime crisis in June and helped drive the euro to a record high against the dollar.
At the weekend the G7 group of top industrialised nations stepped up their criticism of currency volatility, but the euro has still chalked-up fresh records against the dollar.
Jean-Claude Juncker, Luxembourg’s prime minister and the chairman of monthly meetings between euro zone finance ministers and the ECB, said on Thursday that markets had not taken on board the G7’s message, causing the euro to fall.
Weber, asked about Juncker’s remarks, said only that the G7 statement spoke for itself.
But he went into more detail about the turmoil which has wracked global financial markets since last summer.
“Adjustment processes in global financial markets are far from over and … they will continue to be painful. But some positive signs are also emerging now indicating that the worst may be behind us,” he said.
Financial markets were exerting a pro-cyclical effect on the world economy, exaggerating booms and busts, making it even more important to quickly put in place new regulations proposed at the G7 meeting of major industrialised democracies last weekend.
The ECB would also continue its policy of lending extra funds to money markets for as long as tensions persist to try to restore confidence, Weber said, noting that an auction of funds scheduled for July would provide finance out to 2009.
Overall though, Europe’s economy was still in good shape, even if growth this year and next would be somewhat below potential, Weber said.
“For the euro area and Germany, the economic outlook is still favourable.” German GDP had probably grown by about 0.75 percent in the first three months of the year, he added.

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