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ECB-inflation to ease as oil falls but no all-clear

Euro zone wage demands cannot be allowed to spiral higher even if declines in oil prices look like they might bring inflation down more quickly than expected, European Central Bank officials said on Saturday.

Attending meetings with European Union finance ministers, central bankers expressed optimism euro zone inflation would continue to retreat from a 4% peak seen in June and July given oil prices had dropped nearly $50 per barrel in the last two months, falling below $100 for the first time since April. Although there was a chance inflation could fall below the ECB’s 2% ceiling earlier than 2010, the estimate given by ECB President Jean-Claude Trichet, this depended on avoiding any oil price rebound or a damaging upward spiral in wages. “To go for wage price increases in these circumstances would be catastrophic,” Trichet told a news conference after a two-day meeting of European Union finance ministers and central bankers in the French city of Nice.

Such comments are in line with market expectations that the ECB’s next monetary policy move will be to cut interest rates from their current seven-year high of 4.25%, although policymakers gave no sign that this was imminent. ECB Vice-President Lucas Papademos said cheaper oil prices would bring inflation down but commodity markets remained volatile and the central bank had to take a medium-term view. “It’s essential to assess these developments in oil prices in the medium term as these markets are characterized by considerable volatility,” he told reporters. “In the coming weeks and months it cannot be excluded that we may witness a further rise in the price of oil and commodities which may have adverse implications for price developments.”

Germany’s Axel Weber, regarded as one of the ECB’s most hardline inflation fighters, said the inflation outlook had improved in the last few weeks with the fall in oil prices. “I don’t think we’re in a situation that we can give the all clear yet and that we’re sure to meet our mandate within the current juncture. But we’re more confident now than a few weeks ago that the recent developments have contributed towards meeting our objective,” he said. “I don’t see us returning to price stability this year, potentially we will move towards price stability in 2009.” In the same vein, Italy’s Mario Draghi said it would be premature to say the oil price fall marked a turnaround.

 
WORRYING WAGES

Weber said there were already pockets of second-round inflation effects, especially in countries where wages were linked to past increases in inflation. “We are quite concerned that some of the wage demands, against the background of the current slowing in the economy, do not fully take into account the economic perspectives and the price developments that we foresee for the next one or two years,” the Bundesbank president said.

Other policymakers, including France’s Christian Noyer, said stamping out inflation was the best way to boost the economy, which shrank in the second quarter. Some policymakers have said there may be another contraction in the third, although they have brushed off the prospect of a deep recession. “The only way to restore confidence and relaunch demand is to convince economic actors that inflation will disappear quickly,” Noyer said.

Papademos said growth was likely to pick up in the Q4 of 2008 and in 2009, when the ECB sees a gradual recovery. “We expect a sluggish rate of growth in the Q3 and it’s likely that the recovery will start at a faster pace in the Q4, then in the course of 2009,” he said. “However in the present circumstances there is considerable uncertainty around this likely path and downside risks prevail.” (Reuters)