ECB Steps Up 0.25% - Elevated Inflation To Last For A While

Thursday, August 03, 2006

With its 4th step, bringing the leading Euro overnight lending rate to 3%, the European Central Bank (ECB) has followed its mandate to combat inflation in the Euro area. It has every reason. In his remarks ECB president Jean-Claude Trichet not only repeated his warnings on the dangerous impact of record oil prices and runaway money supply growth, he also changed his inflationary outlook:
"Turning to price developments, ... annual HICP inflation was 2.5% in July 2006, unchanged from June and May. In the second half of 2006 and on average in 2007, inflation rates are likely to remain above 2%, the precise levels depending very much on future energy price developments."
Before, the ECB had seen inflation return to a level of not more than 2% in 2007. It could be significantly more, concedes the ECB.
"Risks to the outlook for price developments have augmented and include further increases in oil prices, a stronger pass-through of past oil price rises into consumer prices than currently anticipated, additional increases in administered prices and indirect taxes, and - more fundamentally - stronger than expected wage and price developments owing to second-round effects of past oil price increases at a time of gradually improving labour markets."
Euro money supply growth shows a lot of inflationary potential too, hovering above 8% for M3 and 11% for M1 this year, continuing an up-trend that began in mid-2004. The ECB has failed to meet the M3 target rate of first 4% and now 4.5% since the start of the Euro. Currently consumers are sitting in the driver's seat of the almost stalled Euro economic bandwagon. Says the ECB:
"Looking at the counterparts of M3, the expansion of credit to the private sector remains the main driver of monetary dynamics. On an annual basis, loans to the private sector as a whole have continued to increase at double-digit rates over recent months, with borrowing both by households and by non-financial corporations rising rapidly. Ongoing strong lending to households continues to be explained, in particular, by borrowing for house purchases. The dynamic growth of money and credit, in an environment of already ample liquidity, points to increased upside risks to price stability at medium to longer horizons. Monetary developments therefore require careful monitoring, particularly in the light of strong dynamics in housing markets."
It appears as if the ECB will have to steer through the same rough seas of economic indicators as the Fed.
Most notable is the shift in the timeframe. Until now the ECB had seen all problems panning out short-term. Oil prices on a permanent plateau have extended this perspective to medium-term worries.
The difference between official inflation figures and the prices rises every European feels painfully in his wallet - first filled with credit - will not make the ECB's task any easier.

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