ECB warns of inflation risks

While the ECB predicted that the recent upward inflationary pressures caused by higher energy prices would gradually disappear, its December bulletin raised the prospect of domestic prices continuing to rise.

Pointing to its staff projections showing consumer prices edging back in the next two years, the bank said: "This pattern reflects an assumed downward profile of oil prices, which is, however, projected to be offset by a gradual increase in domestic price pressures."

The bank said that the rate of increase in prices for non-energy industrial goods and services had been increasing slightly over recent months.

This, the ECB argued, reflected "a gradual pass-through of past rises in oil prices to consumer prices." The ECB, however, was particularly concerned about eurozone member states failing to control expenditure and fueling price pressures.

"In this respect, the expansionary bias of fiscal policies implied in the budget plans for 2001 of several euro area countries threatens to add to demand-induced inflationary pressures in the euro area," the bulletin said.

Although the ECB accepts that both the world and eurozone economies are likely to slip back a gear in the coming months, it believes that both the eurozone and the world economy will continue to churn out solid growth performances.

According to the ECB, "the underlying dynamism of growth continues to prevail" in the eurozone. Combined with signs of a strengthening in headline inflation in the 11-member euozone and the renewed market confidence in the common currency, the ECB's comments are likely to confirm economists' forecasts that European rates are on hold for sometime.

The ECB's comments are also likely to check the recent build-up in expectations in sections of the financial markets that the bank would deliver an early cut in interest rates. The bank last increased its key refinancing rate by 25 basis points at the start of October to 4.75 per cent.

After edging down in October, annual inflation in the eurozone jumped to 2.9 per cent in November, the European Commission's statistics office said this month.

While the ECB believes that signs of weaker U.S. economic growth along with the eurozone's sturdy economic fundamentals have helped to underpin the euro, it believes that the recent weakness of the common currency has contributed to the recent renewed inflationary pressures.

After slumping to an all-time low of below 83 cents in October, has the euro has managed to claw back about eight per cent of its value against the dollar piercing 91 cents on Thursday to hit a four-month high.

Taking into account the recent trend in M3 money supply to overshoot the ECB's target, the bank also insisted that "caution continues to be warranted with regard to the upside risks to price stability stemming from the monetary side."

At its last meeting on December 14, the ECB's governing council held its M3 target at 4.5 per cent, with the December bulletin saying that the bank had decided to leave the rate unchanged so as to imply "continuity with the monetary policy strategy conducted in the past."

(dpa)