Euro zone inflation falls but ECB seen on hold

The European Union statistics office said consumer prices in the 15-country euro area fell 0.1% month-on-month and confirmed its earlier estimate of a 3.8% year-on-year rise, down from 4.0% in July. Prices in annual terms expanded more slowly thanks to slower growth in energy prices, which rose 14.6% in August against 17.1% in July. Food, alcohol and tobacco prices increased by 5.6% against 6.1% in July.

What the European Central Bank calls core inflation, a measure excluding the often volatile energy and unprocessed food prices, was 2.6% year-on-year, up from 2.5% annual gains in each of the previous three months. “The rise in core inflation in August reinforces belief that the ECB will not cut interest rates before 2009 despite the increasing danger of euro zone recession,” said Howard Archer, economist at Global Insight. “Nevertheless, we expect euro zone inflation to head down significantly over the rest of 2008 and through 2009, helped by lower oil and commodity prices as well as favorable base effects,” he said.

The ECB looks at core inflation to gauge whether fuel and food price rises are triggering price growth in other sectors of the economy in what it calls second-round inflation effects, which it is determined to prevent through interest rate rises.

Economists said the rise in core inflation would reinforce the ECB’s concerns that second-round effects remained a danger. “Core inflation will continue to gradually move higher as past rises in commodity prices and accelerating labor cost growth filter through,” said Nick Kounis, chief European economist at Fortis. “This should keep the ECB’s inflation worries alive -- and combined with a gradual recovery in the economy from the Q4 onwards -- is likely to keep the central bank on hold.” A broader core inflation measure used by many economists, which excludes energy as well as food, alcohol and tobacco, rose to 1.9% yearly in August against 1.7% in July.

The ECB wants inflation to be just below 2% over the medium term and raised interest rates at the start of July by 25 basis points to 4.25% to better anchor rising inflation expectations. The bank expects to bring back inflation to its target only in 2010, but economists expect that a slowing euro zone economy will make the bank cut rates already in the H1 of 2009.

Meanwhile in Britain, the inflation rate rose to its highest level in 16 years in August and more than double the UK central bank’s target, requiring the Bank of England to explain publicly, why prices are rising so fast. The British Office for National Statistics said consumer prices rose 0.6% on the month, taking the annual rate to 4.7% from 4.4% in July. (Reuters)