ECB faces dilemma on rates

31st August 2004, Comments 0 comments

1 September 2004 , BERLIN - The European Central Bank (ECB) is expected to keep its benchmark interest rate at a historic low of two per cent when it meets Thursday as it sizes up worries about the threat posed to the economic recovery and to inflation by high oil prices. Underscoring the dilemma facing the bank's 18-head rate-setting council, official data released Tuesday shows inflation in the 12-member eurozone stuck at 2.3 percent and consequently above the ECB's two per cent inflation target. Borrowi

1 September 2004

BERLIN - The European Central Bank (ECB) is expected to keep its benchmark interest rate at a historic low of two per cent when it meets Thursday as it sizes up worries about the threat posed to the economic recovery and to inflation by high oil prices.

Underscoring the dilemma facing the bank's 18-head rate-setting council, official data released Tuesday shows inflation in the 12-member eurozone stuck at 2.3 percent and consequently above the ECB's two per cent inflation target.

Borrowing costs in the eurozone have been on hold since June last with many analysts believing that the unsteady economic pickup, high unemployment and sluggish consumer demand means that the ECB will shy away from joining other central banks in tightening monetary policy and possibly keeping rates at their present level into next year.

But having consistently missed its inflation target and facing a round of grim consumer price data in the run-up to the end of the year, some analysts think that the ECB and its hawkish governing council might be forced to bring forward rate hikes to December.

"Because the development of the oil price without doubt is an important risk role in euro monetary market forecasts, we believe that a rate hike around this year's end as likely," said Michael Schubert, economist with Commerzbank AG.

With many ECB council members returning from their summer vacations this week, Thursday's meeting of the bank's governing council will also be followed by the first press conference by ECB chief Jean-Claude Trichet for two months.

The ECB uses the press conferences as a key forum to set out its current thinking on monetary and economic developments and as a result the Trichet's press conference will be closely watched by financial markets for any hints of a change in the bank's views.

Trichet will also use the press conference to unveil the bank's latest growth and inflation forecasts.

In a French television interview last week Trichet appeared to foreshadow the line he is likely to take at the press conference arguing that even when the recent jump in energy prices are taken into account there was no need to revise downwards the ECB's growth forecasts for economy built around the common currency.

But since the last Tichet's press conference on 1 July, oil prices have surged to within USD 50 a barrel and signs have emerged that economic growth may have already started to plateau in the world's three biggest economies - the US, the eurozone and Japan - as a result, triggering talk that the global economy has hit a soft spot.

Eurozone growth slowed to 0.5 percent quarter-on-quarter in the three months to the end of June compared to 0.6 percent in the first quarter. Economists expect eurozone growth this year to fall short of two percent.

Analysts are expecting Trichet to again emphasise at Thursday's press conference that the ECB is not losing faith in the recovery.

Soaring energy costs have already raised the prospect of the eurozone's inflation rate remaining above the bank's two per cent target for much of the year with many analysts believing that the ECB will be forced to concede in its new forecasts that inflation next year will also remain above two percent.

A year ago the ECB forecast an inflation rate this year of 1.4 percent. But while the ECB doggedly insisted throughout the first half of the year that the eurozone was on course to a moderate upswing, data to be released in the days leading up to governing council's meeting is likely to underscore the fragile state of the currency bloc's recovery.

Key economic sentiment surveys have already retreated from recent strong showings.

In particular, this is expected to include a new batch of downbeat numbers out of Europe's biggest economy, Germany, with figures to be released this week tipped to reveal another slump in retail sales and a further rise in the nation's jobless data.

DPA

Subject: German news

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