The European Central Bank left interest rates unchanged on Thursday and insisted inflation was still its key fear even though risks to growth were taking hold, prompting markets to scrap bets on rates rising again this year.
ECB President Jean-Claude Trichet said growth in mid-2008 would be substantially weaker than at the start of the year and the central bank had only partially anticipated the scope of the slowdown. “The latest economic data point to a weakening of real GDP growth in mid-2008, which in part was expected,” Trichet said in a news conference after the ECB left rates at a near seven-year high of 4.25%. “We are identifying downside risks since a number of months, and I would say that the information that we had very clearly suggests the materialization of those risks,” he added, citing higher food and oil prices and a global growth downturn.
Last month the ECB raised rates by a quarter percentage point, the first rise in more than a year, and Trichet said that data since then had vindicated this decision. He confirmed the ECB’s stance of “no bias” on monetary policy and no pre-commitment on future rate moves, and said that the current level of interest rates was helping to get inflation back under control. The biggest change in the ECB’s assessment was on the growth outlook, after many indicators dropped to levels last seen in 2003, when ECB rates were at their all-time low of 2% and economic growth fell to just 0.4%.
Many economists think output has been falling in recent months, and Trichet repeatedly sidestepped questions about whether the ECB now saw a euro zone recession. Fresh ECB staff projections would be published next month and he did not want to go past previous predictions of a “trough” in growth in the second and third quarters, he said. As growth data weakened over the past month, analysts had steadily discounted the likelihood of any further rate rises this year, and Trichet’s gloomy comments reinforced their mood. “The main development over the past month seems to be that the ECB is more downbeat about the euro zone’s current growth situation and the outlook,” economist Howard Archer from consultancy Global Insight said. “Unchanged interest rates seem highly likely in the near term at least as Mr Trichet indicated that the ECB continues to hold a neutral stance.”
The euro weakened against the dollar after Trichet’s growth remarks, and euro zone government bond and interest rate futures rallied as traders dropped any chance of more rate tightening this year. Poor profit results from firms including French insurance giant AXA and Germany’s Dresdner Bank added to the downbeat mood on markets.
Nonetheless, the ECB’s main job is to keep inflation just below 2%, and with price growth running at a record 4.1% in July, Trichet stressed that the bank had not taken its eye off the ball. “This worrying level of inflation rates results largely from both direct and indirect effects of past sharp increases in energy and food prices at the global level,” he said. “We have one needle in our compass and we take absolutely all the information that (is) pertinent to identify the risks for inflation in the months and years to come.”
Inflation was likely to remain above-target for a long time, he conceded. In June, ECB staff forecast that inflation would average 3.4% in 2008 and 2.4% in 2009, though since then oil prices spiked up to nearly $150 a barrel before falling to below $120. “The peak of the price of oil and commodities was very abnormal and not corresponding to equilibrium in price. But we will see what happens,” Trichet said. “‘Volatile’ captures pretty well the evolution that we have seen in the most recent period.”
The ECB was especially concerned that firms were passing on higher raw material costs rather than settling for lower profits, and that workers did not accept a falling standard of living as oil prices rose. “Risks to price stability ... remain clearly on the upside and have increased over the past few months,” Trichet said, declining to answer questions about whether slower growth would take the heat out of inflation pressures.
In Germany, long a bastion of wage restraint, national flag-carrier Lufthansa had to cancel a fifth of flights on Thursday as wage disputes drag on. (Reuters)