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European Inflation Stays Above Target

CNBC.com with Reuters
Friday, 4 Jan 2008 | 10:55 AM ET

High oil prices, driving up the cost of transportation and other services, as well as spiraling food prices, contributed to euro-zone inflation staying well above the target while Swiss inflation came in at a 12-year high, data showed on Friday.

But central banks will have a tough job in containing price rises as rising interest rates in the current environment of economic slowdown may prove difficult.

Most analysts predict the two central banks will stand pat and wait for the inflationary pressures to subside as the prospect of slowing economic activity dampens consumption.

A first estimate from the European Union's statistics office Eurostat showed on Friday that consumer prices among the countries using the euro last month rose 3.1 percent year-on-year, the same as in November. The figure was in line with economists' forecast by economists.

The ECB wants to keep inflation just below 2 percent but a surge in oil and food prices since September has knocked it off target after a year of success.

"Today's data have highlighted the uncomfortable position that the ECB is in," said said Howard Archer, economist at Global Insight, noting that inflation was substantially above the ECB's target, while the December service sector purchasing managers' survey pointed to growth facing serious headwinds.

Services Cool Down

Activity in the euro zone's services sector, which generates some two thirds of gross domestic product, cooled to a 2.5-year-low in December, separate data showed on Friday.

New ECB Governing Council member Athanasios Orphanides said on Thursday the bank would be ready to raise rates if necessary and that policymakers are extremely worried about inflation.

But economists said tough talk was one thing and action another. They said that while high inflation would not allow the ECB to follow the Federal Reserve in rate cuts to underpin growth, waning economic activity also precluded a rate rise.

"Inflation will remain uncomfortably high for the ECB. The ECB is firmly on hold for the time being with the weak growth outlook compensating for these high inflation figures," said Michael Hume, European economist at Lehman Brothers.

Swiss Inflation Hits Psychological Level

Swiss inflation hit its highest level in over 12 years driven by rising transportation costs, data showed on Friday, highlighting the risk that the Swiss National Bank may have to raise rates to fight price pressures.

The rise of consumer price inflation to 2.0 percent in December boosted the Swiss franc and interest rate futures have now all but wiped out any pricing in of SNB rate cuts in 2008.

Consumer prices rose 0.2 percent compared to November, the Federal Statistics Office said, taking the annual inflation rate to its highest since October 1995.

Economists polled by Reuters had expected the yearly rate to inch up to 1.9 percent from 1.8 percent in November.

"Prices rose (on the month) in nearly all categories," the statistics office said.

Transport and Energy

Rising fuel and rail ticket prices drove costs for transportation up, while rents and prices for energy also increased strongly compared to December 2006.

"We have reached the psychologically critical 2 percent level," said Sarasin analyst Jan Poser.

"Core inflation looks rather muted still and therefore the SNB has no immediate need to act," he said. "However, the central bank has to remain very vigilant as economic growth is still strong."

The SNB, which left its benchmark interest rate unchanged at 2.75 percent in December, said in its policy assessment that inflation could rise above its threshold for price stability -- of 2 percent in the first half of 2008.

But the central bank also said the inflation outlook for the medium term had improved as an expected global economic downturn was likely to dampen price pressures.

The SNB expects an average inflation rate of 1.7 percent in 2008 after 0.7 percent in 2007 and 1.1 percent in 2006.

Interest rate futures show that markets expect the central bank to keep rates on hold throughout 2008.

The franc extended recent gains on the data, trading around 1.6370 per euro, after it has long been under pressure as investors make use of Switzerland's low interest rates to invest in higher-yielding currencies in carry trades.

Contact Europe: Economy

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