PERSISTENT forecasts that the next ECB rate move would be downwards got a reality check after the governing council held its monthly meeting in Frankfurt on Thursday.
In its briefing afterwards ECB president Jean Claude Trichet made it clear inflation pressures were still the major worry, despite the real threat posed by the global slowdown to Europe.
But the eurozone grew above trend at 2.2% in the first quarter, suggesting growth is far from dead.
By contrast inflation at the end of May was back up at historic highs of 3.6%, having eased slightly in April.
To make matters worse, the bank’s own internal assessment of price inflation for this year and next have been raised higher.
Forecasts from ECB staffers have led to significant upward revisions to the outlook for the cost of living index within the 15 eurozone states.
ECB inflation estimates have gone up from 2.9% in March to 3.4%.
If that turns out to be the figure, then it would be a record overshoot of the core target figure of just under 2%, Simon Barry, senior economist with Ulster Bank pointed out in his analysis of the ECB’s hardening stance.
Of greater significance was the upward revision of next year’s inflation figure from 2.1% to 2.4%.
In each case the rates are higher than the mandated figure of just under 2%, the ECB is obliged to meet.
In effect the forecast anticipates a tenth consecutive inflation overshoot relative to the ECB’s goal of “close to but below 2%”, Mr Barry said.
Ironically, the hike, if it comes, will hit Ireland’s inflation rate, because mortgage increases are included in the Irish CPI.
However the ECB operates off the harmonised index which does not include the rise in the cost of mortgages in the eurozone basket of goods on which the index is based.
In another twist, the threat of a rate hike saw the euro gain again against a seriously weakened dollar.
That forced investors to switch from dollars to oil to protect their investments, forcing oil up by over $5pb on the day.
Oil surged again yesterday on the back of the EU rate threat and was up over $2pb.
At just under $130pb it was trading $5 below the record peak of slightly north of $135pb it hit last month.
Analysts said the surge was again due to the threat by the ECB to raise rates next month.
At this stage the ECB is in a dilemma irrespective of what decision it takes, a point neatly demonstrated by the near instant hike in the cost of oil.
However, some economists believe the ECB has been guilty of woeful timing on this question.
European growth will fall over the next 18 months anyway, dragged down by the global slowdown, and as a result prices would self correct without any hikes.
Austin Hughes, economist with IIB Bank, says the proposed interest rate change has already done damage.
Surging commodity costs are driving eurozone inflation, which will not be reversed by rate hikes, he argues.
But the dilemma facing the bank is that rising inflation ultimately leads to demand for higher wages, as workers seek compensation for the loss of purchasing power.
And to be fair to the bank it has, since the credit crunch hit last August, postponed raising rates which it was expected to increase from 4% to 4.25% in September last year, followed possibly by a further 0.25% increase by the end of 2007.
But for the credit crunch, ECB rates would be higher tan they are due to the inflation pressures in the European economy.
From an Irish perspective there is no doubt that the threat of a rate hike could not have come at a worst time for us.
© Irish Examiner Ltd. All rights reserved