ECB's Weber Says Market Bet on Rate Cuts is Wrong

Market expectations that the European Central Bank will cut interest rates fail to consider the dangers of higher inflation, ECB Governing Council member Axel Weber said on Wednesday.

Euro zone inflation is unlikely to fall back to its target of below 2 percent in 2008 and the ECB's December forecast of 1.8 percent inflation in 2009 is likely to prove too low due to record oil prices, the German Bundesbank president said.

By contrast, the German economy is solid and the euro zone economy is only likely to slow to just below its long-term potential rate this year, Weber said.

"Against this backdrop ... the current dominant market consensus on interest rate expectations clearly underestimates the inflation risks. These expectations do not drive the monetary policy view of a central bank which is committed to price stability," he said.

Most economists expect the ECB to cut rates from their current 4 percent by the end of June at the latest, according to a Reuters poll published on February 19. The euro briefly extended gains towards earlier record highs on Wednesday against the U.S. dollar after Weber's remarks.

Weber did not address the euro's strength in his speech to top politicians from Germany's ruling coalition of conservatives and social democrats, and declined to comment on the subject to reporters at the event.

"It's another confirmation that the ECB is not ready to cut rates," said Niels Christensen, FX strategist at Nordea in Copenhagen. "They are still worried about the inflation outlook and this view is supported by strong German data."

Weber said above-inflation wage deals threatened to entrench the current record inflation rate of 3.2 percent and the ECB would take action if long-term inflation expectations seemed to be rising significantly.

"If we see a marked upward trend that would be a clear signal for us to take action on interest rates, he said.

Solid Growth

After its March 6 policy meeting the ECB is expected to publish an update to its December staff economic projections which forecast growth of around 2 percent and inflation of about 2.5 percent in 2008.

The International Monetary Fund and many private sector economists expect the U.S. economic slowdown to drag euro zone growth down to about 1.6 percent this year.

Weber said that the world economy would weaken slightly this year as U.S. growth prospects were "significantly more clouded".

"Indicators since the start of the year point to a marked loss of momentum. However, we do not assume a long-lasting cooling down of the U.S. economy," he said.

Oil prices, which set a fresh record earlier on Wednesday, were a further risk to growth, he said.

For the euro zone "we have a picture of growth slightly below its trend potential but see no danger of recession however," he said.

"Though we have recently seen a range of indicators slowing slightly or significantly they are still at high levels. Unemployment ... is at its lowest level in 25 years."

Weber urged Germany's politicians to follow a course of fiscal discipline and write European Union budget deficit rules into national law. He said the country did not need a fiscal stimulus plan like the United States'.

He also said mergers would strengthen Germany's state-controlled Landesbanks, which have been hit hard by credit market turmoil since July.