ECB Stands Firm Against Inflation

By Jennifer Yousfi
Managing Editor

After voting to hold rates steady at its monthly meeting yesterday (Thursday), European Central Bank (ECB) President Jean-Claude Trichet said a rate hike in July is "possible."

Inflation in the Eurozone is running at a 16-year high.  And on Wednesday, the Organisation for Economic Cooperation and Development (OECD) boosted its inflation prediction to 3.4% in 2008, well above the ECB's 2% target.

Policymakers voted to keep the central bank's key interest rate at 4.0%. The ECB also held its two other key rates - the deposit rate and the marginal lending rate - unchanged at 3.0% and 5.0% respectively, the AFP reported.

"The ECB is trapped," Joerg Kraemer, chief economist at Commerzbank AG (OTC: CRZBY) in Frankfurt, told Bloomberg News. "We have the problem of persistently high inflation rates, while growth is weakening. I expect them to keep rates on hold for a very long time."

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But with prices for food and fuel soaring across the Eurozone, merely holding rates steady might not be enough for the hawkish ECB.

A rate increase next month "is not excluded," Trichet said, but "is not certain," adding that the ECB never "precommits" to a move and that the policymakers would only make a final decision on the day they meet.

Separately, the Bank of England also voted to hold its key interest rate steady at 5.0%.

"Inflation is painfully high and the negative effect on purchasing power is squeezing the life out of the [Eurozone] economy," Ken Wattret, an economist at BNP Paribas SA in London told Bloomberg. "It now looks increasingly like a consumer recession is unfolding."

Economic growth is slowing, as even Germany, the European Union's largest economy, has experienced some softening and an up-tick in unemployment. The OECD revised its growth projection down to just 1.7 % this year and to 1.4% in 2009, AFP reported.

Contrasting Currency Effects

Europe's central banks have clearly made inflation their priority, a stark contrast to the U.S. Federal Reserve's aggressive rate-cutting campaign. The Fed has slashed 325 basis points from the key Fed Funds rate since mid-September. The key U.S. interest rate now stands at just 2.0%, well below that of its European counterpart, putting more pressure on an already weak greenback.

Comments from Fed Chairman Ben S. Bernanke on Tuesday acknowledged the weakening effect the U.S. rate cuts have had on the dollar.

Speaking via satellite at the International Monetary Conference in Barcelona, Spain, Bernanke said the Fed is working with the Treasury to "carefully monitor developments in foreign exchange markets." The Fed Chair said he was aware the effect of the dollar's decline on inflation and price expectations, Bloomberg News reported.

It is widely expected that the Federal Open Market Committee (FOMC) will vote to remain on pause at its next meeting scheduled for June 24 - 25.

Bernanke's comments gave a slight boost to the dollar, only to be reversed by Trichet's allusion to a possibly ECB rate hike in June.

The dollar lost ground against the euro to trade at $1.559 in mid-morning trading today, up from $1.547 at the New York close the day of Bernanke's remarks.

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