As Food, Raw Materials Soar, Europe’s Central Bank Head Warns on Inflation
Inflation fearsâ€”fueled by spiraling food, oil and raw material pricesâ€”are mounting around the globe, prompting the head of the European Central Bank to signal that it could raise interest rates in the future even though some countries have been weakened by the Continent’s debt crisis.
Jean-Claude Trichet, president of the European Central Bank, pictured last week at a euro group finance ministers meeting in Brussels.
In an interview with The Wall Street Journal ahead of this week’s annual meeting of the World Economic Forum in Davos, Switzerland, Jean-Claude Trichet warned that inflation pressures in the euro zone must be watched closely, and urged central bankers everywhere to ensure that higher energy and food prices don’t gain a foothold in the global economy.
Mr. Trichet’s warning comes at a time when inflation concerns are mounting among investors around the world. Fast-growing emerging markets such as China and Brazil are seeing rising inflation at home, and their demand for globally traded commodities is pushing prices higher elsewhere.
While high unemployment and spare capacity are restraining underlying inflation pressures in the U.S. and elsewhere in the developed world, annual inflation in China is almost 5%â€”and a sizzling 9.8% economic growth rate in the fourth quarter triggered fears of more price pressures ahead. Inflation in Brazil is even higher.
With the global recovery still in its early stages, those moves could accelerate. Higher raw material prices, especially coal and iron ore, are pushing up steel prices across the globe. Steelmakers including AK Steel and Nucor in the U.S., and China’s Baosteel and South Korea’s Poscoâ€”the world’s second and third largestâ€”have been steadily increasing prices in recent weeks. The world average carbon-steel price is forecast to exceed $1,000 per metric ton by the second half of 2011, up from an average $733 last year, according to U.K.-based consultancy MEPS.
“All central banks, in periods like this where you have inflationary threats that are coming from commodities, have toâ€¦be very careful that there are no second-round effects” on domestic prices, said Mr. Trichet in his office overlooking Frankfurt’s financial district.
Global inflation isn’t just coming from volatile commodities that track the ups and downs of the world economy. Fast-growing emerging nations are taking increasingly aggressive actions to beat back rising food prices as they grow more worried about threats to stability.
Mr. Trichet’s remarks come as the ECB must balance a widening debt crisis in Southern Europe and Ireland with a robust recovery in its largest member, Germany, and rising inflation throughout the euro bloc.
Last month, inflation unexpectedly jumped to 2.2% in the euro zone from 1.9%, the first time in more than two years it has exceeded the ECB’s target of just below 2%. Some economists say it will rise above 2.5% in the next two months.
In Greece, Ireland and other countries on the euro zone’s periphery, austerity drives are pushing up unemployment and bringing additional pain to economies already struggling with the effects of burst credit bubbles. Many economists worry that higher interest rates would do further damage in such countries, where the interest burdens on high private-sector debts are closely linked to the ECB’s policy rates. Mr. Trichet rejected calls to take special heed of stragglers on the euro zone’s fringe.
“All countries in the euro area have an immense stake in the solid anchoring of inflation expectations,” he said.
Mr. Trichet first ratcheted up his anti-inflation rhetoric at his monthly news conference earlier in January, spurring many economists to move forward their forecasts for rate increases.
In the interview, he dismissed some economists’ argument that the ECB should hold off on raising rates because euro-zone “core” inflation, which excludes food and energy prices, was still weak at 1.1% in December.
“In the U.S., the Fed considers that core inflation is a good predictor for future headline inflation,” he said. But in the euro zone, “core inflation is not necessarily a good predictor.”
That implies the ECB could raise rates this year if it senses that companies and workers expect headline inflation to stay above 2% for some timeâ€”even if the main source of inflation is world commodity markets.
Changes in food and energy prices are largely determined on world markets, and thus aren’t directly influenced by interest rates in any one economy. For that reason, central banks in many major economies, including the U.S., put greater weight on core inflation than on headline measures. For now, Fed officials don’t see much evidence that commodity prices are feeding broader inflation in the U.S.
The Fed isn’t expected to raise its key interest rate for some time, in order to help the U.S. economy recover despite signs of rising headline inflation. The Bank of England has yet to raise rates, though U.K. inflation is approaching 4%. The potentially divergent U.S. stance is reminiscent of what happened in the summer of 2008, when the ECB raised short-term interest rates in the face of rising oil prices while the Fed held rates steady amid concerns about economic growth.
Mr. Trichet argues that budget discipline would help growth in Europe more than renewed stimulus, and called on the euro zone’s 17 member countries to strengthen “surveillance” of each other’s fiscal policies. In Europe, budget discipline benefits growth and job creation by “improving confidence of households, enterprises, investors and savers,” said the 68-year-old Frenchman.
In contrast, the U.S. is extending fiscal stimulus this year as Federal Reserve Chairman Ben Bernanke tries to boost growth through a government bond-buying program.
Mr. Trichet’s inflation warnings signal a symbolic shift from the crisis mentality that has dominated ECB policy for much of the past three years back to its traditional roleâ€”keeping prices stable. It also helps shore up his anti-inflation credibility in Germany, where officials and the public have been skeptical of the ECB’s decision last May to buy government bonds of Greece, Ireland and Portugal.
Still, Mr. Trichet’s remarks suggest that, for now, his tough talk is aimed at keeping inflation expectations in check rather than signaling an imminent rise in rates. If consumers see energy- or food-driven price increases as temporary, they are less likely to alter their behavior or push for higher wages. But if workers expect permanently higher inflation, they are likely to press for faster pay rises. “At this stage, we do not see” those longer-term forces, Mr. Trichet said, “and everybody knows we would not let [such] second-round effects materialize.”
To boost investor and consumer confidence, Mr. Trichet said, euro-zone nations should sign up to stricter rules on budget discipline, including credible sanctions for miscreants. Euro-zone governments are currently negotiating a slate of overhauls to their bloc’s economic governance, including more-generous aid for countries in a debt crisis, that they hope will restore investor confidence in the finances of the zone’s weaker economies.
Although governments have so far declined to agree to tougher penalties for budgetary indiscipline, Mr. Trichet hasn’t given up. The European Parliament might yet force national governments to stiffen the rules on sanctions, he said, praising its ability to do “what is essential for Europe.”
He repeated his call to national leaders to make the euro zone’s bailout fund for crisis-hit members bigger and more flexible, while declining to comment on specific measures currently under debate.
Struggling countries on the euro zone’s fringe, including Greece, Ireland and Portugal, face an extended period of economic pain: They must raise taxes and cut spending to reduce government debt, while holding wages down to make their products more price-competitive. At the other extreme, Germany’s mix of rapid, export-driven growth and tumbling unemployment usually puts central bankers on edge because it often leads to rising wages and prices. Other euro-zone countries, such as France, are somewhere in the middle. Their economies are recovering, but growth remains uneven with unemployment high.
Mr. Trichet dismisses these divergences as normal, and similar to those among states and regions in the U.S. But the U.S. and other large economies have big federal budgets that can channel funds from prosperous areas to those that have fallen on harder times. Europe doesn’t have a central fiscal authority, putting pressure on the ECB to stabilize a diverse set of economies with one interest-rate tool.
He brushed off skeptics of Europe’s focus on budget austerity, including the International Monetary Fund and, recently, the United Nations, which warned “the impact of fiscal austerity planned or under way risks a renewed economic downturn” in Europe.
“I do not buy the very simple reasoning that would suggest that pursuing sounder fiscal policy would hamper growth,” Mr. Trichet said.
â€”Jon Hilsenrath and Robert Guy Matthews contributed to this article.