ATHENS, 7 October 2005 — The European Central Bank, the euro zone’s inflation watchdog, growled and bared its teeth here yesterday as runaway oil rates pushed up consumer prices in the 12-country euro zone, but the bank stopped short of biting just yet. The guardian of the euro, meeting in the Greek capital instead of its usual home venue of Frankfurt, held its key rates steady as expected for the 28th month in a row.
The ECB held the minimum bid rate for its regular refinancing operations at 2.00 percent, where it has been since June 2003. And it also held its two other key rates - the deposit rate and the marginal lending rate - unchanged at 1.00 percent and 3.00 percent respectively.
The ECB decision came shortly after the Bank of England announced it was also holding its own key interest rate steady at 4.50 percent. At a news conference after the meeting, ECB chief Jean-Claude Trichet insisted that the bank continued to view the current level of borrowing costs in Europe as “appropriate.”
Nevertheless, high oil prices meant that the bank had to remain “strongly vigilant” with regard to the upward risks to price stability, the Frenchman insisted. “Strong vigilance is warranted,” Trichet said.
High oil prices were putting “renewed upward pressure” on headline consumer prices - the harmonized index of consumer prices (HICP) for the 12 countries that share the euro rose by 2.5 percent on a 12-month basis in September, sharply higher than the ECB’s ceiling of 2.0 percent.
“It is essential that these risks do not translate into higher inflationary pressures,” Trichet said. However, the ECB saw no “clear evidence” that such underlying pressures were building up just yet. And while that remained the case, the ECB was not preparing the markets for a tightening move, Trichet said. “I’m not pre-announcing a rate hike,” he said, but warned that the ECB would act when necessary.
The bank’s decision-making governing council did indeed “discuss the pros and cons” of a possible increase in interest rates at its meeting in the Greek capital, Trichet said. “We discussed pros and cons both of a rate hike and of leaving rates unchanged,” but there was no discussion of a rate cut, the Frenchman said. At the same time as fueling inflation, high oil prices also posed a risk to growth, Trichet said.
“The outlook for economic activity remains subject to downward risks, relating mainly to oil prices, concerns about global imbalances and weak consumer confidence,” he said. Nevertheless, such risks notwithstanding, the ECB continued to believe that area-wide growth would pick up “from the second half of this year onwards,” Trichet said.
ECB watchers detected a more hawkish tone in Trichet’s comments than in previous weeks. The bank “edged closer to a rate hike today (Thursday),” said Bank of America economist Holger Schmieding. “Since briefly flirting with a possible rate cut in late May and early June, the ECB has progressively hardened its language, moving from ‘ongoing vigilance’ in July to ‘particular vigilance’ in September and ‘strong vigilance’ now. The ECB cannot become much more concerned about inflation without actually having to hike rates,” Schmieding said.
Given the rate of change in Trichet’s tone, the ECB might be preparing to tighten monetary conditions in the euro area early next year, the analyst suggested. However, that depended on whether area-wide growth picked up as expected.
“Although we do not expect euro zone growth to stall in late 2005, we expect overall growth to remain well below trend until early 2006, partly due to the extra burden placed upon consumers by high oil prices,” Schmieding said. So, “we consider it more likely that the ECB will hold its fire until next spring,” he concluded.
For Dresdner Bank economist Claudia Broyer, the hardening of Trichet’s tone was a tactic to show the markets that it was serious about tackling inflation without actually having just to act just yet. “The ECB barks but it doesn’t bite straight away,” Broyer said.
While the bank remained caught between low growth and rising inflation, “words won’t be followed by action just yet,” she said, forecasting a tightening move only in the middle of next year. Citigroup economist Juergen Michels agreed. The important thing was the ECB’s credibility, he said. “The markets continue to believe the ECB can keep prices stable,” he said.
Analysts had not expected any change to the rate, even in the face of growing worries that high energy prices and weak consumer spending are dampening increasing demand for European exports from boom economies in Asia. All 43 experts surveyed by Dow Jones Newswires thought rates would remain unchanged.
Britain also held its official interest rate steady at 4.5 percent for the second consecutive month, following a quarter point rate cut in August aimed at stimulating economic growth. Demand from the global economy for European goods has so far cushioned the bloc against the impact of high oil prices, which “have taken their toll” on the 12 countries that use the euro, the EU head office said Thursday.
The European Commission made no change to its forecast for gross domestic product to grow by 1.6 percent this year. That is more cheerful than EU finance ministers, who last month said they expected energy prices to slow growth to between 1.1 percent and 1.3 percent this year. A gloomier view came yesterday from independent economists at the European Forecasting Network, who predicted 1.2 percent growth in 2005, rising to only 1.8 percent in 2006 and 2 percent in 2007.
The EFN, which groups the ten top economic research institutes employed as consultants by the European Commission, predicts that inflation will stay “at or close” to 2 percent.
