ECB warns on inflation risk, holds interest rates steady

07 May, 2004

The European Central Bank warned on Thursday that inflation is in danger of heating up as the eurozone economy gradually strengthens, effectively pushing the prospect of an interest rate cut off the agenda.
Meeting in Helsinki, the ECB left interest rates steady at 2.00 percent for the 11th straight month, again ignoring the pleas for a cut to speed up economic growth that eurozone political leaders had made until recently.
ECB President Jean-Claude Trichet stressed the bank is keeping its options open and has no bias on the direction of rates. But he also dropped hawkish hints that coincide with a shift among many leading central banks toward costlier money.
Trichet cited oil prices that are heading toward $40 a barrel as a new risk that needs close monitoring. "At the current juncture, the increase in commodity prices in general and oil prices in particular may pose an upside risk to price stability," he said.
Inflation may go above the ECB's 2.00 percent benchmark in the next few months, he added.
Earlier in the day the Bank of England raised its interest rates and the US Federal Reserve this week prepared markets for a "measured" pace of rate hikes in due course.
Bond analysts took Trichet's comments as a sign that monetary easing is over. "Prospects of a euro zone rate cut ... are now dead," said Jon Lee, international rate strategist at Barclay's Capital in London.
Bond markets fell partly on the ECB assessment and on a drop in US weekly jobless claims, in expectation that rate increases may come sooner. The euro weakened a little toward $1.2093.
The chances of an ECB rate cut have been dwindling as a global rebound broadens and even European politicians have become less vocal in their appeals for cheaper money.
Trichet said that while economic data is mixed, there are reasons for optimism.
"The information has been more encouraging, with the latest euro area survey data offering more positive signals with regard to the beginning of the second quarter," he said.
But doubts remain over whether the recovery has staying power. The eurozone services sector barely improved in April, signalling domestic demand is still growing too slowly to power a broader economic take-off. German industrial orders for March unexpectedly fell on Thursday, including foreign orders.
Despite this slow growth, senior eurozone officials have said recently the ECB Governing Council is loath to cut interest rates beyond their already historic lows, questioning whether lower rates can do the trick.
"The reason for this slow upswing is a mixture of problems, which the ECB cannot influence with interest rates," said Joerg Kraemer, an analyst at Invesco Asset Management in Frankfurt.
Prime among these are government fiscal problems. Roughly half the 12 eurozone countries have broken the budget deficit rules that underpin monetary union - notably the two biggest states France and Germany - and they face political difficulties pushing through steep cuts in social programmes.

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