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Euro-Zone Inflation, Sentiment Signals ECB on Hold
By: Reuters | 28 Sep 2007 | 07:26 AM ET
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Euro zone inflation rebounded in September above the European Central Bank's target for the first time in a year but market turmoil depressed economic sentiment, making another ECB interest rate rise less likely.

European Union statistics office Eurostat estimated prices in the 13 countries using the euro rose 2.1% year-on-year against 1.7% in August.

That was in line with forecasts of economists, who had expected inflation to pick up because of a surge in oil prices compared to the same period of 2006. However, no breakdown of the September estimate or monthly data was yet available.

The data is likely to fuel the European Central Bank's concerns about price stability as the bank wants to keep inflation below, but close to 2.0%.

Even though the bank left interest rates unchanged at 4.0% in September to help calm financial markets amid a global credit crunch, it has signaled it could raise them further due to upside inflation risks.

Economists expect price growth to stay above the ECB target in coming months because of gains in the cost of oil and food.

"We expect inflation to drift higher from this level in the remainder of the year, reaching 2.4% by December, and presenting more of a headache for the ECB as it pauses to consider the likely fallout on an already slowing euro zone economy," said Eoin O'Callaghan, economist at BNP Paribas.

Credit Crunch Hits Sentiment

Eurostat said economic sentiment in the euro zone fell sharply in September to 107.1 points from a downwardly revised 109.9 in August, marking the lowest reading since May 2006.

This was the first indication of the impact of the global credit crunch, caused by the U.S. subprime mortgage market crisis, on the economy of the euro zone as a whole.

Economists had expected a decline to only 109.2 as a result of market turbulence in August and September.

"The economic sentiment in the euro zone has suffered a strong setback. The financial market crises have unsettled business and consumer confidence. Therefore risks are growing that the crises will dampen economic growth," said Christoph Weil, economist at Commerzbank.

"We assume that the ECB will give up its tightening bias in the coming months," he said.

The drop in sentiment is likely to herald a slower economic expansion this year and next, as already seen in downward growth revisions by the European Commission and the ECB.

Slower growth could remove some upward inflationary pressure and therefore limit the need for further ECB rate rises, especially as market turbulence has already boosted three-month borrowing rates to 4.8% against the ECB's 4.0%.

The rising euro, boosted by expectations of rate cuts in the United States against stable or rising ECB rates, is also helping to contain inflation, but hurting exporters.

Consumer inflation expectations, which the bank closely watches in its policy decisions, inched up to 27 points from 26 in August, rising to December 2006 levels. But selling price expectations among companies fell two points to 11.

The mixed signals are therefore likely to keep the ECB in a wait-and-see mode in coming months, economists said.

"An extended period of rates at 4.00% currently looks on the cards," said Howard Archer, economist at Global Insight.

Copyright 2009 Reuters. Click for restrictions.
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