European Central Bank policymakers stressed on Wednesday their readiness to keep tightening monetary policy if growth or inflation dangers strengthen - an increasingly likely prospect after the European Union raised its 2006 forecasts.
Political pressure on the ECB came back into focus when EU Economic and Monetary Affairs Commissioner Joaquin Almunia said the central bank could benefit from better dialogue with Europe's finance ministers.
Bundesbank President Axel Weber, who sits on the ECB's Governing Council, struck a hawkish tone when he said the bank might have to raise rates more than expected if the risk of higher inflation materialised.
"Recent developments have been positive but the risks in the medium-to-longer term are such that if they were to be realised, further action over and above that envisaged in our main scenario would be warranted," Weber told reporters.
"A marked deterioration in the price outlook could call for stronger action. We do not go by the calendar, but depend on economic developments," he added.
Markets have been pricing in two more quarter percentage-point rises in ECB rates to 3.5 percent by the end of the year, but there has been much more uncertainty about what the bank will do after that.
Weber hinted that rates could rise beyond 3.5 percent when he said that real interest rates - the ECB benchmark rate minus headline consumer inflation - needed to be above 1 percent before they stopped giving extra stimulus to the economy. With eurozone rates now at 3.0 percent, and ECB staff forecasting about 2.4 percent inflation this year, the real rate is just 0.6 percent.
"A real interest rate of a half or even one percent is not consistent with rates close to a neutral level," Weber said. There was no decision to end the process of "normalisation" by the end of the year, he said.
Weber's comments got back-up from fellow Governing Council member Erkki Liikanen, Finland's central bank governor, who said rates were still historically low, despite four increases since last December from a record low of 2.0 percent. Liikanen and Weber's comments nudged the euro upwards, and dealt a blow to eurozone rate and bond futures.
"Weber's saying we'll get to 3.5 percent this year and don't assume the ECB will rest at that," said Dario Perkins, European economist at ABN Amro in London. "We think they'll continue with tightening bias into next year and see 4.00 percent - probably by the middle of the year."
Perkins said Weber was probably the Governing Council's most hawkish member, and his views were likely not to reflect the current consensus - but the past year had shown both data and consensus tended to move in the hawks' favour.
The ECB raised its growth and inflation forecasts last week, and it was the European Commission's turn on Wednesday, increasing its 2006 GDP forecast to 2.5 percent from 2.1 percent, and that for inflation to 2.3 percent from 2.2 percent - comfortably above the ECB's goal of price growth just below 2 percent.
Economic and Monetary Affairs Commissioner Joaquin Almunia gave tacit backing to some further tightening of policy, saying that a recent easing in headline inflation "cannot be maintained without positive action from monetary authorities".
But he also said for the first time that there should be closer dialogue between himself, ECB President Jean-Claude Trichet and Luxembourg Prime Minister Jean-Claude Juncker, who represents eurozone finance ministers.
"That dialogue can be improved, should be improved because it is something that works in the interests of both institutions, the Eurogroup and the central bank," he said.
Trichet has been cool to this idea, not even replying to a letter from Juncker earlier this year suggesting the same. Trichet has said that he attends monthly meetings of eurozone finance ministers (Eurogroup), and that Juncker and Almunia can sit in on twice-monthly ECB Governing Council meetings.
Almunia also said that were it up to him, he would not hesitate to reappoint Juncker to represent the eurozone for another two years when his term ends at the end of the year.
But Juncker said last week that he would continue this role only if he could be sure of better relations with the ECB. "My decision to continue for another two years depends on several points which must be clarified and on which I insist, notably on the role of the Eurogroup in relation to the ECB," he said.
Though Almunia said closer dialogue must not damage the independence of the ECB, the central bank is keen to keep the views of finance ministers at a distance from policymaking. Germany, France and Austria all urged the ECB earlier this week to act cautiously when raising rates.