Eurozone inflation soars to 14-year high

Eurozone inflation soars to 14-year high

By Ralph Atkins in Frankfurt

Published: January 31 2008 11:04 | Last updated: January 31 2008 17:53

Eurozone inflation has surged to a 14-year high of 3.2 per cent, strengthening the European Central Bank’s case for resisting interest rate cuts even as the region’s growth slows.

In spite of sharp cuts in US interest rates by the Federal Reserve, the ECB is widely expected to leave its main interest rate unchanged at 4 per cent after its meeting next week.

The surprise pick-up in inflation, from December’s 3.1 per cent, indicated that the “hump” in inflation caused by higher fuel and food prices is proving larger and longer-lasting than the ECB anticipated. January’s rate was the highest since the ECB took responsibility in 1999 for monetary policy in the eurozone, which now covers 15 countries. It is also above its target of an annual rate “below but close” to 2 per cent.

However, the ECB’s task has been complicated by signs that eurozone growth is slowing markedly as the global financial crisis unfolds. Economic confidence in the region has tumbled to the lowest level since early 2006, according to the European Commission. Its “economic sentiment” indicator fell from 103.4 points in December to 101.7 points.

Eurozone growth is typically less volatile than in the US. But Julian Callow of Barclays Capital said past history suggested a “quite significant” chance of the region falling into recession in the next two years.

Financial markets assumed the ECB would eventually respond to the mounting gloom, and have priced in two quarter percentage point cuts in ECB interest rates later this year.

Still, the eurozone slowdown is not yet severe.

The service sector and consumers have seen the sharpest falls in confidence, according to the Commission’s survey, and German retail sales figures on Thursday showed spending in Europe’s largest economy fell by 2.2 per cent in real terms last year.

But financial services play a less important role than in the US and UK, and the eurozone is less exposed to tumbling house prices.

Meanwhile, eurozone industry remains relatively upbeat, in spite of the euro’s strength.

Germany also reported an unexpectedly sharp 89,000 drop in seasonally adjusted unemployment to the lowest level for 15 years – almost certainly the delayed results of its industrial renaissance since the start of the decade.

Eurostat, the European Union’s statistical unit, warned that the latest “flash” inflation estimate was “more uncertain than usual” because of statistical changes in Germany.

However, the acceleration in January probably again reflected higher food and fuel prices, analysts said.

Annual inflation is generally forecast to ease during this year but the ECB’s fear is that the temporary rise will become longer-lasting if it feeds through into wage demands.

Such “second round” effects in the eurozone “have tended in the past to be stronger than in the United States,” Simon Johnson, the International Monetary Fund’s chief economist, warned earlier this week.

The ECB’s tough language has been aimed recently at sending a strong signal during the current round of wage negotiations.

Eurozone inflation had been expected to moderate in January as the effects of last year’s three percentage point rise in German VAT dropped out of year-on-year comparisons.