Inflation hawks eye Commission report

Date: 10/11/05

Controversy over the EU's economic outlook and the interest rate policy of the European Central Bank's (ECB) will intensify next week when the European Commission releases its autumn economic forecasts.

The Commission's figures will lay the foundations for expected battles with such countries as Germany, France, Italy, Portugal and Greece over the implementation of the Stability and Growth Pact's excessive deficit procedure. "The Commission's forecasts provide a benchmark against which national governments' projections will be measured," said one Brussels-based economist.

The Commission's view will also help to shape the argument over whether or not the European Central Bank should raise interest rates from the historically low 2% level that has prevailed since June 2003.

In recent weeks senior ECB officials, including President Jean-Claude Trichet, have been perceived to be preparing the financial markets for a rate increase. On Monday (7 November) Trichet said: "Central banks cannot sacrifice their hard won credibility in the face of high oil prices that continue to threaten price stability....we need to anchor solidly inflationary expectations."

Later that day, however, at a meeting of eurozone finance ministers in Brussels, Trichet was left in no doubt about the strength of the opposition to such a step as the ministers made clear their belief that an interest rate increase next month would be premature.

Despite the Eurogroup stance, Axel Weber, president of the Bundesbank, warned on Wednesday (8 November) that "the risks to price stability have increased in recent weeks", adding that there was "very abundant liquidity which signals very strong inflation risks over the medium and long term". According to Julian Callow of Barclays Capital in London, these hawkish comments suggested a "very considerable risk," of an ECB rate rise on 1 December.

The ECB fears that with interest rates at historically low levels and credit growth strong, higher oil prices and higher inflation could feed inflationary expectations.

This could trigger "second round effects", such as unions demanding higher wages to compensate them for losses in purchasing power.

Jean-Claude Juncker, the Eurogroup president, played down some of these concerns after the Eurogroup meeting, saying there was no evidence of inflationary second round effects. "The spillover from high oil prices has been largely absent so far," he said.

There are fears, too, about the sluggish eurozone economic recovery. Last month the Commission, while still seeing economic recovery ahead, cut its growth forecast for 2005 from 1.6% to 1.2%. Economists point out that EU growth is still too dependent on exports and consumer demand remains weak.

Germany accounts for around one-third of the Eurozone economy. It has benefited from three years of wage moderation and the associated gains in competitiveness. Its new government seems likely to put budget consolidation high on its agenda. So it will certainly not be anxious to see rates rise. Neither will France, particularly given the current wave of civil unrest.

The global economy, too, could be heading for an unsettled period. US growth is widely expected to slow to under 3% in the fourth quarter under the impact of the recent hurricanes and higher interest rates and this will test the resilience of an American economy which is dependent on foreign lenders to finance its huge current account deficit.

Ernest-Antoine Seillière, president of UNICE, the European employers' lobby, warned this week against raising interest rates. UNICE has cut its growth forecast for the eurozone in 2006 to 1.8 % cent (from 2.2%) "An early increase in interest rates, or signal thereof, could trigger renewed upward pressures on the euro. This would put businesses in difficulties," said Seillière.

Private-sector economists are divided about whether the ECB will, or should, raise rates next month. José Luis Alzola of US bank Citigroup in London said that he shared the view that the eurozone economy recovery would continue next year but he did not expect a December rate increase from the ECB until the upturn was more solidly founded, perhaps by March. But Elga Bartsch of investment bankers Morgan Stanley in London said she now thought there would be a rate increase this year.

• Stewart Fleming is a freelance journalist based in Brussels

Article anticipates the release of the European Commission's 2005 autumn economic forecasts and takes a look at the controversy over the EU's economic outlook and the interest rate policy of the European Central Bank (ECB).