MADRID/HAMBURG, May 26 - Inflationary pressures are receding, European Central Bank officials said on Monday, giving the ECB some flexibility to consider interest rate cuts in a weak economy. But the flurry of comments on the price outlook still left analysts wary of predicting any hefty reduction in rates next week given the ECB's reputation for caution and its well advertised view that the economy is on track for recovery.
"Our expectation is that the inflation rate will be below two percent this year," ECB Executive Board Member Eugenio Domingo Solans said at a business school address in Madrid.
Ernst Welteke, ECB Governing Council Member, had a similar forecast in a speech to business leaders in Hamburg. "After inflation in April was 2.1 percent, the inflation rate should fall further in the coming months," he said. Improving prospects for price gains to fall below the ECB's target of two percent gives policymakers room for manoeuvre on monetary policy, Domingo Solans told reporters. "Yes. (Fighting) inflation is our objective and certainly it is the element we take into account in order to take interest rate decisions."
Their remarks are in harmony with a widening circle of ECB officials who say that falling oil prices and euro strength provide leeway for easier credit. But central bankers also retain a cautious tone. Even though the economy now is stagnant, they stress that recovery is on track for later this year and euro strength no barrier to growth. So market analysts remain unsure how deep a rate cut from the current 2.50 percent official rate level the ECB might deliver at its June 5 policy meeting.
"We're expecting a quarter point rate cut. We're hoping for something more, but the ECB has the reputation of taking their time before cutting, and then they do not always cut by the amount the economy needs," said Menno Middeldorp, economist at Rabobank in Utrecht.
DEFLATION FEARS "ALARMIST"
Moreover, ECB officials in recent days have made clear that they are not about to pump money aggressively into the euro zone economy to ward off a damaging deflationary spiral of falling prices. Such deflationary fears are "alarmist", ECB Executive Board Member Tommaso Padoa-Schioppa said in a newspaper interview. "There is only slowing inflation and weak growth -- phenomena which the European Central Bank is following closely, ready to act if necessary," he told La Repubblica.
Similarly, ECB Executive Board Member Otmar Issing this weekend told a German TV station that he knows no forecasts that show deflation is a reason to act on rates right now. The International Monetary Fund has warned Germany faces a high risk of deflation, and ECB Governing Council Member Yves Mersch on Friday did say that Germany could face a short deflationary period.
But Welteke disagreed, saying there were no signs of deflation in Germany, while Issing provided assurance that were it to threaten, the ECB would act promptly to rub it out.
EURO STRENGTH BEARABLE
Neither are ECB officials raising eyebrows over the robust euro currency , up 13 percent this year against the dollar and nudging close on Monday to its record high of $1.1886 -- even though some businesses and politicians are complaining it will hurt exports. Austrian Central Bank Deputy Governor Gertrude Tumpel-Gugerell, who joins the ECB Executive Board on June 1, said in a radio interview the euro rate is "bearable" while both Welteke and Issing said its surge merely brings the currency back to more normal levels.
Still, euro strength is clearly one factor to nudge the ECB toward a rate cut because it serves to dampen import prices. "Of course this is an element which we take into account in our assessment of the economic conditions in order to take monetary policy decisions," Domingo Solans said. Critical to the size of any rate cut will be the ECB's assessment of economic recovery, which officials say will be delayed until the latter half of the year. Welteke, for instance, welcomed a pickup in German business confidence in May but he also pointed out that it is not yet a trend.
"Uncertainty due to geopolitical tensions has indeed declined following the end of the Iraq war, but it has not disappeared as the latest attacks in Saudi Arabia and Morocco indicate," he said. Issing was more graphic: "It will not be the case that a motor gets going and suddenly storms ahead. It will be a rather gradual process."//www.l.com