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Will Inflation Force Euro-Zone to Raise Rates?

Antonia Oprita,|Associate Web Producer
Friday, 30 May 2008 | 6:47 AM ET

On the verge of the European Central Bank's 10th anniversary, the news on inflation doesn't look good. Against the bank's target of "below but close to" 2 percent, euro-zone prices rose 3.6 percent in May, compared with the year ago,back to a historic high, data showed on Friday.

For a bank that has the sole mandate of price stability, it could be argued that it's time to bump rates up from 4 percent.

But the hawkish central bank is unlikely to deliver a shock to the markets by raising rates, despite evidence that price rises in Belgium hit a 23-year high of 5.21 percent and in Spain inflation quickened to 4.7 percent, analysts told CNBC.com.

"I don't expect them to do anything next week," Erste Bank euro zone analyst Veronika Lammer said. "We still have a high-risk premium on money markets."

She said the inflation figure was a "negative surprise" for the markets but that, with crop harvests approaching in the Northern hemisphere and with oil prices probably cooling a bit, euro-zone inflation may have peaked.

But hawkish comments are likely to grow stronger.

"I think there's quite a strong group in the ECB that is advocating raising rates," Stefan Schenider, euro zone analyst at Deutsche bank, told CNBC.com. "I guess for the time being this is not the majority view."

No More Volatility

Money market rates are still tight, Schneider said, while uncertainties about further developments in the financial markets are still in the limelight and the bank looks very closely to tensions in the credit markets.

"The last thing they want to do is add volatility to the markets," he said. "Everyone in the ECB knows that they can do with interest rates what they want, they cannot, in the short term, reduce food or oil prices."

Most analysts expect more hawkish talk and no action, at least until the end of this year.

"My colleagues in the ECB Governing Council - like Juergen Stark and Axel Weber -- and I are concerned about the current high prices," ECB President Jean-Claude Trichet said in an interview with Bild newspaper on Friday.

"I have already said on behalf of the ECB Governing Council: We have to take care that the current price shocks in oil and food prices do not lead to increases in other goods and inflated wage agreements, which in turn will trigger inflation and a wave of wage increases," Trichet said.

But signs of weakness abound in the euro zone despite much-better-than-expected economic growth figures for the first quarter. German retail sales fell surprisingly for the second month in a row in April while gloomy news keeps coming from France, Spain and Italy.

"By the end of the year we'll have more weakness than the ECB expects," Schneider said.

Contact Europe: Economy

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