The European Central Bank (ECB) kept interest rates at a record low on Thursday as policy makers grapple with an oil-price shock that’s driving inflation beyond the bank’s limit while also threatening to damp economic growth.
ECB officials meeting in Frankfurt set the benchmark rate at one per cent for a 23rd month, as predicted by all 53 economists in a Bloomberg News survey. President Jean-Claude Trichet, who holds a press conference at 2:30 p.m., may toughen his inflation-fighting language and leave open the option of raising borrowing costs later this year, economists said.
“Inflation fighting is definitely Trichet’s first priority,” said Nick Kounis, an economist at ABN Amro in Amsterdam. “A significant and sustained rise in the price of oil could derail the recovery, but at the moment the focus is on keeping prices under control.”
Investors last week increased bets on the ECB raising rates as soon as August after policy makers including board member Juergen Stark said they will act if needed to stop soaring commodity prices from driving up price expectations. Trichet must balance those inflation concerns against the risk of exacerbating Europe’s sovereign debt crisis by removing stimulus too soon. In addition to keeping rates low, the ECB is lending banks as much cash as they want and buying government bonds.
‘Upside’ risks
Trichet may indicate whether the ECB intends to resume its exit from non-standard policy measures. It has so far pledged to keep offering banks unlimited amounts of cash in its weekly and three-month refinancing operations through the first quarter.
He will also unveil the central bank’s latest growth and inflation forecasts.
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The ECB will probably raise its 2011 inflation estimate to more than two per cent from 1.8 per cent and may conclude that risks to the outlook have moved to the “upside,” Governing Council member Yves Mersch said in an interview published on February 22. Inflation, which the bank aims to keep just below 2 per cent, accelerated to 2.4 per cent last month.
“We’ll see significant changes in inflation forecasts, especially for this year,” said Carsten Brzeski, senior economist at ING Group in Brussels. “But the projections will already be outdated because the latest oil-price spike came too late to be included.”
$100 a barrel
Political tensions in Libya, the latest country to experience a wave of anti-government protests in North Africa and the Middle East, pushed crude prices above $100 a barrel on Feb 23. Libya, which ships most of its crude and fuels to Europe, has cut oil production by more than half, the International Energy Agency said on February 25. Oil traded as high as $102.94 a barrel on Thursday.
Federal Reserve Chairman Ben S Bernanke said on March 1 that the surge in oil and other commodity prices probably won’t cause a permanent increase in broader inflation and repeated that US borrowing costs are likely to stay low.
By contrast, China on February 8 raised rates for the third time since mid-October, and three of the Bank of England’s nine policy makers last month voted for an increase.
ECB Executive Board member Lorenzo Bini Smaghi said in an interview published on February 18 that commodity-price increases will have an “unavoidable impact” on euro-region inflation and the bank may need to take “pre-emptive actions.”
Second-round effects
The ECB is concerned about so-called second-round effects, when companies raise prices and workers demand more pay to compensate for soaring energy and food costs, entrenching faster inflation.
Henkel AG, a German maker of industrial and consumer chemical products, said on February 24 it will raise prices in all businesses and all regions this year in response to rising raw material costs.
The ECB is “prepared to act decisively and immediately if needed” to prevent an “un-anchoring” of inflation expectations, Stark said on February 21.
Investors expect the ECB to raise its key rate to 1.5 per cent by the end of the year, with the first quarter-point increase fully priced in for September, Eonia forward contracts show.
The euro-area economy is showing signs of gaining strength. Manufacturing growth accelerated to the fastest pace in more than 10 years in February as companies ramped up production to meet export demand. In Germany, Europe’s largest economy, business confidence unexpectedly rose to a record high and unemployment dropped to 7.3 per cent, the lowest in two decades.