The European Central Bank would be right to raise interest rates due to robust economic growth but need not increase them by more than financial markets expect, the International Monetary Fund said on Tuesday.
Markets expect the ECB to raise interest rates by 25 basis points to 4 percent on Wednesday and again later in the year to stem inflationary pressures from fast credit growth and a tightening labour market. That is a prospect, which has sparked criticism from some eurozone countries, notably France.
"We see a need for tightening in monetary policy but the extent and the pace is uncertain," the head of the IMF's European division, Michael Deppler, told a news conference, adding that interest rates were within a neutral range.
"The general expectation is that inflation is going to firm gradually. That calls for gradual tightening in monetary policy," he said, a day after presenting a regular review of the economy to eurozone finance ministers and the ECB.
In a rare show of support for higher ECB rates from a eurozone finance minister, Greece's George Alogoskoufis said more expensive credit would not hurt the fast-growing Greek economy: "ECB monetary policy for an economy growing as fast as Greece is not bad as there's always a risk of overheating."
But German Finance Minister Peer Steinbrueck, asked if he and other eurozone ministers shared the IMF's view on ECB rate rises, said: "We listened very carefully to Mr Deppler but you don't always have to agree with the IMF."
The IMF expects eurozone inflation to remain around 2 percent this year and next, while the ECB wants to keep inflation below but close to 2 percent in the medium term. Deppler noted investors were expecting the ECB could raise interest rates to 4.25-4.5 percent by year-end. "I would not see any need for anything beyond that, thinking in that timeframe," he said, as wage demand and labour costs looked moderate.
He forecast the eurozone's growth of about 2.5 percent in 2007 would continue in the foreseeable future - above what the IMF sees as its potential growth rate of 2.25 percent.
The European Commission expects growth of 2.6 percent this year and 2.5 percent in 2008, just below the six-year peak of 2.7 percent in 2006. Pouring water on French calls for a weaker euro to help economic growth, Deppler said the currency's effective exchange rate was compatible with sustained growth.
Greece's Alogoskoufis also told reporters the euro's relative strength was not hurting his country's trade too much. Deppler joined the European Commission and Steinbrueck, whose country holds the rotating EU presidency, to urge countries with budget deficits to use growth to cut them.
Euro zone finance ministers on Monday stood by a pledge to balance their budgets by 2010 but without a firm commitment from France. Its 2008 budget plans will be finalised only after parliamentary elections this month. New French President Nicolas Sarkozy has raised the prospect of a pause in deficit-cutting by promising a series of tax cuts.
"Certainly, countries which remain significantly away from balance should continue to adjust (their budget deficits) by at least 0.5 percentage points per annum," Deppler said. Like eurozone finance ministers on Monday, Deppler recalled mistakes of the past when governments used higher tax revenues to boost consumption rather than shore up public finances.
"In an upturn everybody starts to relax and you only start to regret that when the cycle turns a few years later," he said. In a sign of how EU public finances are improving, the 27 finance ministers ended a five-year row with Germany over its excessive deficit on Tuesday after Berlin brought the gap sharply below EU limits last year and pledged more cuts. "Germany will honour its obligation to reduce its deficit to zero by 2010," Steinbrueck told reporters.
Greece, the longest-standing deficit offender, and Malta also exited the disciplinary procedure. For Malta, the decision paved the way for initial approval by EU ministers on Tuesday for its bid, along with Cyprus, to join the eurozone next year.