By Simone Meier, Bloomberg columnist Cheaper oil is helping ECB president Jean-Claude Trichet mee...
By Simone Meier, Bloomberg columnist
Cheaper oil is helping ECB president Jean-Claude Trichet meet his inflation goal. However, it may complicate his task of setting interest rates by spurring economic growth and generating more persistent price increases.
The 20% drop in crude since 14 July pushed the inflation rate in the euro area below the bank's ceiling of 2% in September for the first time since January 2005.
The decline leaves companies and consumers with more money to spend, stoking expansion that is already forecast to be the fastest in six years and making it easier for firms to raise prices.
Economists were almost unanimous in predicting the ECB will raise the benchmark refinancing rate to 3.25% on 5 October and to 3.5% in December. After that, they are divided.
While 11 of the 23 economists who responded to a Bloomberg News survey said rates will stay on hold through 2007, nine predicted increases to as high as 4% and three forecasted a cut to 3%.
"The argument that inflation will ease is difficult to buy because it will be partly offset by domestic price pressures,'' said Stephane Deo, chief European economist at London-based UBS AG.
"The drop in oil prices is increasing the likelihood that the ECB will have to continue hiking interest rates into 2007.''
But this is not the case, according to Holger Schmieding, chief European economist at London-based Bank of America.
"Lower oil prices and the drop in headline inflation will likely force the ECB to substantially downgrade its inflation projections at the next quarterly update in December,'' he said, predicting inflation will average 2.2% in 2007
On 31 August, the central bank said it expected inflation of about 2.4% this year and next, exceeding its goal of just below 2% for an eighth year. It also forecasted economic growth will slow to about 2.1% from this year's 2.5%. The estimates assume oil prices will stay at about $70 a barrel.
Inflation slowed to 1.8% in September after oil prices retreated from a record $78.40 in July. David Brown, chief European economist Bear Stearns International, predicted inflation may slow to as low as 1.5% in the coming months.
Investors have pared bets on rate increases in 2007, futures trading has suggested. Most now expected the bank to keep its benchmark rate at 3.5% next year. The implied rate on the three-month Euribor futures contract for June delivery was 3.76% on 29 September, compared with 3.91% on 18 September.
ECB council members including Germany's Axel Weber and Spain's José Manuel González-Páramo have so far shown little willingness to signal the all-clear on inflation.
It is "premature" to say that lower oil prices will curb inflation and they may instead create "stronger domestic pressure", said Weber on 21 September. While González-Páramo, one of the bank's six Executive Board members, said on 28 September that the ECB needs to show "alertness" on inflation.
Some ECB council members "are going a little bit overboard now in order to achieve their goal of lifting rates once or twice more", said Norbert Walter, chief economist at Frankfurt based Deutsche Bank. "No rate hike at all would be the correct ECB policy."
Other economists point to burgeoning money-supply growth, which the bank views as a gauge of future inflation pressure. Growth in the M3 measure of money supply unexpectedly accelerated to 8.2% in August, twice the rate the ECB considers compatible with an acceptable level of inflation.
Credit to businesses and households, which includes loans and securities such as shares, jumped 11.9% in August the most since the ECB took charge of monetary policy eight years ago.
Europeans' confidence in the outlook for growth rose to the highest in more than five years in September. The euro-region economy grew 0.9% in the second quarter from the first, outpacing the US for the first time in five years on a quarter-on-quarter basis. The US expanded 0.6% on that measure.
The fastest growth since 2000 is encouraging labour unions to demand higher pay rises. Last month, Germany's largest steelmakers ThyssenKrupp and Salzgitter agreed to the highest wage increases in more than 10 years, with 85,000 steelworkers seeing a 3.8% rise from 2007.
"The ECB will continue to monitor the situation very, very closely even if inflation slows,'' said Stephen Webster, chief European economist at 4Cast in London. "It is probably more uncertain on the future rate path.''
Elsewhere, setting rates too high might stifle a pickup in domestic spending just as a slowdown in the US - the destination of about a fifth of Europe's exports - risked damping exports. Growth in the world's largest economy slowed to 2.6% in the second quarter, almost half the pace of the previous three months.
The Federal Reserve left overnight lending rates unchanged for a second straight meeting on 20 September, after lifting them 17 times since June 2004 to 5.25%.
Futures contracts showed that traders see about a 12% chance the bank will cut rates this year as a real-estate slump saps consumer confidence. A month ago, futures reflected about a 50% probability of an increase.
Meanwhile, a separate survey of economists showed the Bank of England would probably leave its benchmark rate unchanged at 4.75% after increasing it for the first time in two years on 3 August.
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