Warning of inflation 'explosion'

By Gabi Thesing  |   2008-7-3  |     NEWSPAPER EDITION

EUROPEAN Central Bank President Jean-Claude Trichet, who may raise interest rates today, said there's a risk of inflation "exploding" if central banks don't act decisively.

"We central banks have a big responsibility," Trichet told Germany's Die Zeit newspaper, Bloomberg News reported. "If we're not decisive, there's a risk of inflation exploding. If we act in a decisive way, we can master the situation." Trichet said on June 5 the bank may raise its key rate by a quarter-point to 4.25 percent at its July 3 meeting to contain inflation even as economic growth slows. Since then, soaring food and energy prices pushed euro-area inflation to 4 percent, twice the ECB's limit. Policy makers are concerned that workers will demand wage increases to compensate for the higher cost of living, entrenching faster inflation.

"Trichet's comments reflect the ECB's position that it will counter any wage-inflation spiral emanating from current inflation rates," said Stefan Bielmeier, an economist at Deutsche Bank AG in Frankfurt. "The ECB's thinking is that even though higher rates may hurt growth in the short term, the longer-term economic fallout would be much worse if it doesn't act now."

The euro and yields on Eonia forward contracts rose after Trichet's remarks were published, as investors raised bets on higher ECB interest rates. They expect the ECB to increase its key rate to 4.5 percent by December, and some expect a further move by March.

Adding to the ECB's concerns, European producer prices jumped a record 7.1 percent in May from a year earlier, the European Union statistics office in Luxembourg said yesterday.

Still, politicians are concerned that higher interest rates will deepen Europe's economic downturn.

European companies are grappling with the euro's 16-percent appreciation against the dollar in the past year, which makes their exports less competitive, and record oil prices of above US$140 a barrel, which are sapping purchasing power.