ECB keeps interest rates steady

The European Central Bank held its key interest rate steady today despite inflationary pressures from high oil prices, but cautioned that “strong vigilance” was needed on rising costs.

The warning from ECB President Jean-Claude Trichet was a step up from his previous talk of “vigilance". He said recent increases in inflation were caused by oil prices and should gradually decline.

“Upside risks to this scenario have, however, increased,” he said, and defended low interest rates as a key part of keeping prices stable.

“There continues to be no clear evidence of domestic inflationary pressure building up in the euro area,” he said.

The ECB has now held its benchmark rate at 2% since June 2003. Analysts had not expected any change to the rate, even in the face of growing worries that high energy prices and weak consumer spending are dampening increasing demand for European exports from boom economies in Asia.

“There is no doubt the language is more hawkish than last time and the ECB is signalling a shift,” said Lorenzo Codogno at Bank of America. “Two words stood out – ‘still appropriate’ and ‘strong vigilance.’ This is a clear signal that the ECB might raise rates,” he said, adding that he thought change was likely in the second quarter of 2006.

Britain also kept its official interest rate steady today, holding at 4.5% for the second consecutive month following a quarter point rate cut in August aimed at stimulating economic growth.

ECB governors at the meeting in Athens – one of two each year that the bank holds away from its Frankfurt headquarters – did not discuss a rate cut, Trichet said.

Fighting inflation is the ECB’s chief mission, though it also must consider the effect that rates have on growth. Ill-timed hikes to combat inflation could dampen growth by raising the cost of borrowing for businesses. Lowering the rates could weaken the euro.

Commerzbank economist Michael Schubert agreed Trichet sounded more hawkish, a sign that he believed Europe’s outlook has deteriorated. “Strong vigilance is appropriate in this situation,” he said.

Euro-zone inflation jumped from 2.2% to 2.5% in September, according to first estimates from the EU statistics agency.

Demand from the global economy for European goods has somewhat cushioned the bloc against the impact of high oil prices, which “have taken their toll” on the 12 countries that use the euro, the EU head office said today.

The European Commission made no change to its forecast for gross domestic product to grow by 1.6% this year. That is more cheerful than EU finance ministers, who last month said they expected energy prices to slow growth to between 1.1% and 1.3% this year.

A gloomier view came today from independent economists at the European Forecasting Network, who predicted 1.2% growth in 2005, rising to only 1.8% in 2006 and 2% in 2007.

The EFN, which groups the ten top economic research institutes employed as consultants by the European Commission, predicts that inflation will stay “at or close” to 2%.

Growth in the euro zone slowed to 0.3% in the second quarter, the EU executive Commission said in its third quarterly economic report, despite an increase in “strong industrial activity” in Germany, the EU’s largest economy.

But the Commission said there were signs that the EU economy had picked up in the second half of 2005, with stronger business confidence, increased industrial output and good financing conditions suggesting that a euro-area recovery was gaining momentum.

Klaus Regling, the head of the EU’s economic and monetary affairs unit, said optimism was returning. However, the EU head office warned that oil prices would pose “a major source of uncertainty” for Europe’s sluggish economy in the months ahead.

“We will probably have to live with continued high (oil) prices for longer than we thought,” Regling said.