Eurozone inflation jump bolsters rate hike view

AP News
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Posted: Mar 31, 2011 8:16 AM
Eurozone inflation jump bolsters rate hike view

) _ Inflation in the 17 euro countries spiked to the highest level in nearly two and a half years in March, official figures showed Thursday _ cementing market expectations that the European Central Bank will raise interest rates next week.

Eurostat, the EU's statistics office, said consumer prices in the eurozone were 2.6 percent higher in March than the year before. That's the highest rate since October 2008 and is way above the central bank's target of keeping inflation at "close to, but below 2 percent."

The increase was not anticipated _ the consensus in the markets was for inflation to remain at 2.4 percent.

Since Thursday provided Eurostat's "flash" estimate for inflation, it included no details as to why inflation rose. Those will emerge in April.

Inflation dropped to zero percent in May 2009, but prices have since pushed higher largely on the back of rising energy and food costs as the global economy starts to grow again following the deepest recession since World War II.

Over the past month, comments from the European Central Bank have been increasingly hawkish on inflation. The bank's rate-setters, including President Jean-Claude Trichet, have been giving heavy hints that the main interest rate will rise from the current record low of 1 percent at the next meeting on April 7.

The bank cut interest rates sharply from 4.25 percent in October 2008 as it tried to stave off the impact from the financial crisis and has kept borrowing costs unchanged at 1 percent since May 2009.

In many ways, it can argue that its strategy worked and it's now time to start "normalizing" monetary policy, despite the ongoing debt difficulties and austerity measures in several countries, notably Greece, Ireland, Portugal and Spain. The eurozone economy as a whole has been growing strongly for over a year now, driven by a healthy rebound in Germany, Europe's biggest economy.

"The ECB will want to move from emergency setup to more normal levels," said Silvio Peruzzo, an economist at the Royal Bank of Scotland.

Peruzzo predicted the bank will begin the new cycle of interest rate rises next week, but he doesn't believe that Thursday's figures will cause undue alarm because much of the increase recorded in March was due to changes in the way food and clothing prices are measured in Italy and Spain.

Expectations that borrowing costs in the eurozone are on their way up have helped support the euro currency over the past few weeks. By early afternoon London time, the euro was trading 0.7 percent higher on the day at $1.4214.

Interest rate increases, or even expected ones, benefit the euro if other central banks don't do the same.

The U.S. Federal Reserve, for example, is not expected to raise its super-low interest rates until the latter part of this year, while the Bank of England's rate-setting committee is fretting about the impact of higher borrowing costs on the fragile British economy.

Michael Hewson, market analyst at CMC Markets, said the key now will be how hawkish Trichet is in the aftermath of next week's "increasingly likely" rate hike and in particular whether he will reiterate his call for "strong vigilance." Throughout his presidency, that's been code for a likely rate rise in the following month.

"As far as the single currency is concerned, it continues to benefit from yield differentials as markets factor in multiple rate hikes throughout 2011, while other central banks such as the Bank of England and the Federal Reserve fret about the effect any planned rise in rates could have on consumer spending and growth," Hewson said.

"It would appear that the ECB has no such worries about that, and seems determined to try and put the inflation genie back in the bottle," he added.