Trichet: Oil prices may worsen inflation

By David McHugh, AP Business Writer | June 3, 2004

FRANKFURT, Germany -- The head of the European Central Bank warned Thursday that higher oil prices could worsen inflation if they persist -- a development that could eventually push the bank toward raising interest rates.

Bank president Jean-Claude Trichet's cautionary remarks came after the central bank's governing council left its key refinancing rate steady at 2 percent, one year after its last move which was cut from 2.5 percent.

While Trichet said that the bank had "no bias" toward higher or lower rates, his repeated remarks on surging oil prices suggested that it sees them first of all as an inflation risk -- rather than as a threat to economic growth.

Worries about rising consumer prices would increase pressure on the bank to raise interest rates, which many economists believe it will do as early as the end of this year.

Trichet was careful to hedge, saying the bank expects that a recent spike in inflation to an annual rate of 2.5 percent in May in the 12 countries that use the euro will subside by next year, and that prices will then fall below the bank's 2 percent ceiling.

But "if they were to remain at their recent high levels, it is to be expected that inflation rates would continue to be higher than previously anticipated and stay above 2 percent for longer than just a few months ahead," he said.

He also repeatedly referred to the bank's legal mission to keep a lid on prices, calling it the "magnetic needle of our compass."

Christoph Balz, senior economist at Commerzbank, said Trichet's "tone is a just little more hawkish" -- that is, leaning more toward higher rather than lower rates.

"Against this background, it's even less likely that the ECB will lower interest rates again," Balz said. On oil prices, Trichet "emphasized the price risk rather than the dampening effect on growth."

Higher oil prices can hurt growth by making raw materials and energy more expensive for businesses, and can push up prices for consumers at the same time, in part by feeding through to higher prices at the gas pump.

Adding to the cautionary tone, the banks' economists raised their projection for 2005 inflation by 0.1 percentage point, to between 1.1 percent and 2.3 percent, and trimmed their growth outlook by 0.2 points to 1.7-2.7 percent.

Asked if Europe faced "stagflation," or a combination of slow growth and high inflation from oil prices, Trichet said that both effects were "highly unwelcome" but that it was "too early to tell."

He urged oil producers to "take account of the situation" so that it remains transitory.

Stagflation puts central banks in a bind because their main medicine against inflation -- higher rates -- can choke off economic growth.

Even though oil prices represent a risk, Trichet said he still expects stronger growth in coming quarters.

"We expect an ongoing recovery in the euro area economic growth over the coming quarters, leading to a broader and stronger upswing in the course of next year," he said, citing first-quarter growth of 0.6 percent over the quarter before.

The euro zone economy grew an anemic 0.4 percent for all of last year, but the bank has predicted stronger growth for months. Trichet acknowledged that economic indicators, including the price of oil, remained mixed and uncertain.

Asked if oil prices could remain high even if the OPEC oil cartel raises production, he did not rule out that scenario.

"We are in a world with a high level of uncertainty," he said. "We will take reality as reality materializes -- and our main responsibility is to maintain price stability."

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