ECB Officials Signal Inflation Still Biggest Concern

By Simone Meier

Sept. 5 (Bloomberg) -- European Central Bank President Jean- Claude Trichet and Executive Board members Juergen Stark and Jose Manuel Gonzalez-Paramo signaled they're still concerned about inflation even with the euro-region economy on the brink of a recession.

The ECB will do ``whatever needed to deliver price stability,'' Trichet said at a conference in Frankfurt today. At the same event, Stark said inflation is at ``worrying levels,'' while Gonzalez-Paramo said in a speech in Spain that the inflation outlook is ``a source of major concern.''

While the euro-region economy is struggling to recover from a second-quarter contraction, the ECB yesterday kept interest rates at a seven-year high to push down inflation, which is running at 3.8 percent. ECB council member Axel Weber has said he sees no room to lower the key rate from 4.25 percent.

``This hawkishness that they're still coming out with about monetary policy, when you've had oil prices 40 percent off the highs and very weak indicators in Germany, for me and I'm sure for many others that is a bit scary,'' Jim O'Neill, chief economist at Goldman Sachs Group Inc., said in an interview in Cernobbio, Italy, today.

The Frankfurt-based ECB yesterday cut its growth forecasts for this year and next to about 1.4 percent and 1.2 percent respectively. It also raised its inflation projections to around 3.5 percent for 2008 and 2.6 percent for 2009. The ECB aims to keep inflation below 2 percent.

`Still Too High'

``Even though yesterday's inflation forecasts show a deceleration of inflation in 2009, it will still be too high and clearly above our definition of price stability,'' Ewald Nowotny, who joined the ECB's Governing Council this month, said in Vienna today. It's too soon to sound the all-clear, he said.

The ECB is concerned that faster inflation will spark so- called second-round effects as companies pass on higher costs and workers demand more pay. Gonzalez-Paramo told reporters in San Sebastian, Spain, that the bank will have ``failed'' if broad- based second-round effects materialize.

``The bank can't fight against oil prices but it can do what is possible to avoid widespread second-round effects in the economy, and we will do that with the instruments we have,'' he said. The risk of second-round effects represents ``a source of acute concern.''

`Critical Challenge'

While crude oil prices have retreated 26 percent from a July 11 record of $147.27 a barrel, they're still up 42 percent from a year ago. ECB council member Athanasios Orphanides said in Frankfurt today that the decline in inflation from its 4 percent peak ``does not suggest a rapid improvement.''

Inflation still poses a ``critical challenge,'' he said. ``We shall always remember that focusing on price stability is the best contribution to stable growth and job creation over time.''

Policy makers expressed confidence that the euro-region economy will start to emerge from its trough from the fourth quarter. Gonzalez-Paramo said the bank expects ``the current episode of weakness to be followed by a period of gradual recovery.''

Stark said while third-quarter economic growth ``will be weak,'' he expects a ``gradual recovery in the course of 2009.'' At the same time, commodity-price increases ``threaten to unhinge inflation expectations,'' he said.

Trichet said it's ``precisely during such difficult times that the benefits of a solid monetary framework oriented to price stability become apparent.''

To contact the reporter on this story: Simone Meier in Frankfurt at smeier@bloomberg.net