Europe Economy

Euro-Zone Growth Resists Turmoil: ECB


Financial market turbulence has so far failed to dent the euro zone economy and inflation dangers remain, European Central Bank policymakers said on Friday.

ECB Governing Council member Nicholas Garganas said price risks could even be worsening, while Executive Board member Juergen Stark said there were no clear signs of weakening in the economy, despite two months of market volatility.

Their comments bolster the chance of further tightening in interest rates once the market turmoil has calmed, although analysts see an extended pause at the current 4% rate.

"My view is that the risks to inflation are, perhaps, increasing," Garganas told news agency Dow Jones in an interview.

"I would think it is more likely than not that inflation in 2008 will be above 2%."

ECB staff forecast inflation to average about 2% in 2008, above the ECB's comfort zone. Stark confirmed the ECB sees inflation "significantly above" 2% for the rest of 2007 and into early 2008, and then some moderation.

Fellow policymaker Axel Weber said late on Thursday that the expected acceleration could mean a need for further ECB action, potentially even taking monetary policy into restrictive territory where it acts as a drag on growth.

But Portugal's Vitor Constancio gave a more cautious assessment, noting that the strong euro helped to offset upward price pressures from oil costs, which have hit record highs above $80 per barrel.

Garganas and Stark brushed off the prospect of the market turmoil severely crimping expansion in the 13-nation region, stressing that economic fundamentals remained sound.

"There is little evidence of an impact (on demand) beyond the decline in confidence indicators," Stark said in a speech in Brussels, published on the ECB's Web site.

But confidence indicators were still above their historical averages and therefore pointed to sustained growth in the second half of 2007, he said.

Garganas said the ECB's main scenario of growth around the potential rate of just over 2% remained on track and said he did not see any major impact on confidence.

"I would think that the impact of the financial market turbulence on euro area growth is marginal, also going forward," he said.

Worst Over?

Garganas said he thought the worst was over in terms of market volatility, a view cautiously echoed by Constancio.

"There is some normalisation in some market segments, including money markets and covered bonds, there are some positive signs," Constancio said.

But the Portuguese central bank governor said financing conditions had become tighter, in contrast to Garganas, who said the impact on financing costs had been "modest."

"There are several factors impacting (inflation). There is the development of oil, partly offset by developments in exchange rates," Constancio told reporters in Lisbon.

"(There are) signs of some more restrictive attitude in lending conditions. All these we have to assess all the time."

Overnight money market rates have come down in recent weeks, prompting the ECB on Friday to announce its second special operation to drain funds from markets within a week.

But policymakers have noted continuing difficulties in borrowing money for longer than a week, as the credit crunch had made banks cautious about lending funds.

Three-month money was quoted at a bid/ask spread of 4.62/4.72% on Friday, well above the ECB's benchmark 4% rate.