Super Inflation - Euro Style

Europe's Uber-Inflation Headache
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The European Central Bank has stubbornly defied its critics by keeping its eye firmly on inflation, and resisting pressure to cut rates. But its policy seems to have had little impact on soaring prices.

The European Commission warned that it expects inflation within the 15 nation euro zone to rise to 3.2% for the year. This adds to pressure on the European Central Bank to refrain from a confidence-boosting interest-rate cut.

The euro rose to $1.5686 on Monday afternoon in Europe from $1.5635 in late Friday trading in New York. The euro's 15.0% rise against the dollar over the past year is particularly painful for the continent's manufacturing companies, whose already-high labor costs rise relative to those in other currency zones.

In its semi-annual forecast, the Commission said that soaring prices of food, oil and metals would raise the cost of producing other goods, sending inflation soaring well above last year's figure of 2.1% and the European Central Bank's target of 2.0%. The commission also offered mediocre forecasts for economic growth this year of 1.7% and 1.5% for 2008. The economy of the eurozone grew by 2.6% last year.

"The moderation in growth results from the persisting turmoil in the financial markets, the marked slowdown in the United States and soaring commodity prices, all of which are taking their toll on global activity," the Commission said on Monday.

The EU Economic and Monetary Commissioner Joaquin Almunia said that while Europe would not head into a recession, he warned that if inflation spiraled it would choke growth. "Inflation has become a major problem for all of us," he told reporters Monday, adding it was important to avoid anything, including wage hikes, that could lead to further price rises.

EU countries are not the only ones that face the dilemma of countering soaring inflation with the need to buoy a flagging economy by lowering interest rates. On Monday Iceland's statistics office said that inflation in April soared to 11.8%, its highest level since 1990. The impact of rising oil and food prices has been compounded by the weakness of the Icelandic krona, pushing up the price of imported goods.

In a move which surprised economists Hungary's central bank decided on Monday to push interest rates up by 25 basis points to 8.25% on Monday, after inflation rose to 6.7% last month.

The European Commission's report piled pressure on the European Central Bank, which has remained consistently hawkish over interest rates. The ECB has faced criticisms from politicians -- notably Italy's prime-minister-in-waiting, Silvio Berlusconi -- who have warned about the damaging impact of a strong euro particularly for economies that are dependent on exports to the United States or to countries with currencies linked to the dollar. (See: "Europe's $1.50 Headache Is Italy's Migraine" )

In a speech on Monday European Central Bank President Jean-Claude Trichet defended the bank's policy, arguing that controlling inflationary pressure contributed to "appeasing tensions and volatility in the financial markets whilst paving the way for future sustainable growth and job creation in Europe."

Because key commodities are priced in dollars, they have been rising against the U.S. currency as the greenback weakness on foreign exchange markets.

In London gold traded as high as $895.80 per ounce, up from $890.10 late Friday.

Oil rose to a record $119.93 in pre-market electronic trading on the New York Mercantile Exchange from Friday's close of $118.52, after BP shut the Forties pipeline that delivers nearly a third of Britain's North Sea oil. The line was closed due to a Scottish refinery strike.
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