31 January 2008International Herald Tribune
Inflation in the euro zone rose at the fastest pace on record in January, official data showed Thursday, highlighting the difficult task facing the European Central Bank as it seeks to enforce price stability in the face of slowing economic growth.
The report came at the end of a stomach-churning month in European stock markets. It served as a reminder that things could get worse, as the twin problems of rising prices and spreading financial market contagion from the ailing U.S. housing market were felt globally.
Consumer prices rose at an average 3.2 percent annualized rate in the 15 countries sharing the euro, according to an initial estimate from the EU statistics agency Eurostat, accelerating from a 3.1 percent pace in December. The January increase was the fastest since the agency began tracking the data in 1997.
Inflation has become a worldwide problem, as oil prices hover above $90 a barrel and the conversion of farmland to grow biofuel crops increases food prices. Global policy makers are being confronted by the very real danger of stagflation - anemic economic growth and upward pressure on prices.
European markets were among the world's hardest hit last month, with the pan-European DJ Euro Stoxx 50 index plunging nearly 14 percent amid concerns for the health of European financial institutions, heavily exposed to problems in the U.S. residential mortgage market.
Wall Street has held up relatively well, in contrast, with the Dow Jones industrial average falling less than 6 percent in January.
But in contrast with his U.S. counterpart, Ben Bernanke, the chairman of the Federal Reserve, who has faced suggestions that he was bailing out investors, the ECB president, Jean-Claude Trichet, has continued to maintain a hawkish tone.
Economists do not expect the ECB to cut its benchmark rate from the current 4 percent before mid-2008 at the earliest, even as the Fed has aggressively cut its main target rate to 3 percent, from 5.25 percent last summer.
The ECB's governing council will meet next Thursday in Frankfurt, and economists almost universally expect the bank to stand firm on rates.
The inflation data Thursday seemed to give backing to the ECB's stance. Nonetheless, economists said price pressures seemed to be so far confined to the food and energy sectors. They also said the problems in the stock market had not yet carried over into the wider European economy.
As long as food and energy are the main cause of inflation, prices will remain contained, said Gilles Moëc, senior economist at the London office of Bank of America. "But if it's spreading to other sectors, we'll be in trouble."
The ECB has resisted increasing political pressure to ease monetary policy, keeping the benchmark interest rate at 4 percent since June. The Fed's aggressive moves, which culminated Wednesday in a half-point rate cut, included a rare three-quarter point cut between meetings last week.
Two separate reports Thursday illustrated the ECB's delicate task. Consumer confidence in the euro zone fell 1.7 points to 101.7, the European Commission reported. That came in spite of relatively strong jobs data. Eurostat also reported that the seasonally adjusted unemployment rate remained unchanged at 7.2 percent in December, but down from 7.8 percent a year earlier.
Thomas Mayer, chief European economist at Deutsche Bank in London, said growth in the euro zone was likely to slow soon, and that policy makers would gain latitude on rates as a result.
"It's reminiscent of the situation in 2001, when the U.S. dot-com bubble collapsed," he said. "Then, too, people argued that Europe would 'decouple' from the U.S. - that turned out to be not the case."
"If you believe growth is slowing significantly this year, you would believe that inflation is at or near its peak," Mayer said. "I strongly believe that growth is about to start slowing."
"Credit and housing markets don't move as closely in sync as the stock market, so Europe is following a little more slowly this time," he said.
Part of the difference between the banks' approaches is that the ECB has a mandate of maintaining price stability, and tries to keep the rate of inflation just below 2 percent, while the Fed has a dual mandate for price stability and full employment. But the two economies are also out of step, economists said.
"There is a big difference between the U.S. and Europe at this stage," Moëc, at Bank of America, said. "In the U.S., the slowdown in the U.S. housing and construction market has had a big impact on growth." In Europe, some markets are slowing, but the impact on growth so far has been negligible, he said.
He predicted that the U.S. economy would grow 1.4 percent this year, versus 1.6 percent in the euro zone.
Moëc said the most important thing for the ECB now were signs of inflation in workers' pay.
"German unions are demanding really generous pay deals," Moëc said, and some wages in France and Spain are indexed to inflation, meaning price pressures could be pushed along quickly.
Axel Weber, the chief of the Bundesbank in Germany and an ECB board member, said on Jan. 25, "We have zero tolerance for a wage-price spiral." He added that if "financial and wage developments threaten to leave the stability corridor, we will act decisively."
Moëc said that ECB action related to stocks would be very unlikely unless there was "a very sharp disruptive fall in equities."
Mayer said that he expected the next ECB move on rates to be "toward the end of the second quarter" at the earliest, though it might move earlier "if we get a few more months like this in the stock market."
