Inflation fear keeps Europe rates on high

By Christian Vits  |   2008-8-8  |     NEWSPAPER EDITION

THE European Central Bank has kept interest rates at a seven-year high to fight inflation, even as evidence of an economic slump mounts.

ECB policy makers, meeting in Frankfurt, left the benchmark lending rate at 4.25 percent, as predicted by all 60 economists in a Bloomberg News survey.

The bank is concerned that the fastest inflation in 16 years will push up wages and prices while record energy costs and the stronger euro strangle growth.

Economic confidence fell last month by the most since the September 11 terrorist attacks and Europe's manufacturing and service industries contracted for a second month.

"The ECB will keep all options open as uncertainty about the economic outlook has risen," said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt.

"However, it has a bias toward raising rates. Its main concern is still inflation."

The Bank of England kept its key rate at 5 percent and the Czech central bank cut its rate a quarter point to 3.5 percent.

Inflation in the 15-nation euro region accelerated to 4.1 percent in July as oil prices soared to a record. The ECB aims to keep the rate just below 2 percent, something it has failed to do every year since 1999.

The bank raised its benchmark rate by a quarter point on July 3, citing its concern that a wage-price spiral may develop.

Negotiated wages in Germany, Europe's biggest economy, jumped 3.5 percent in the year through April, the biggest gain in 12 years.

In Italy, wage inflation accelerated to 3.6 percent in June.

Euro-region retail sales fell for a second month in July and German factory orders unexpectedly dropped for a seventh month in June, driven by a slump in exports.

Oil prices retreat

Oil prices have retreated 18 percent since reaching a record US$147.27 a barrel on July 11 and money-supply growth, which the ECB uses as a gauge of future inflation, slowed more than economists forecast in June.

"Slowly but surely, the arguments for another interest-rate rise are running out," said David Milleker, chief economist at Union Investment GmbH in Frankfurt. "The focus will shift more and more to the economic slowdown."

The ECB in June forecast euro-region economic expansion of about 1.8 percent this year and 1.5 percent in 2009.

David Mackie, chief European economist at JPMorgan Chase and Co in London, said a lot has happened since the ECB lifted its policy rate at the July meeting.

"But it is too soon to expect a dramatic shift in rhetoric. While we are sympathetic to the idea that the ECB could ease next year, it is likely to be a slow journey," he said.