The European Central Bank is expected to keep interest rates steady on Thursday as surging oil prices raise risks of higher inflation and weaker spending. ECB policymakers, who will take their interest rate decision in a telephone conference ahead of a four-week summer break, are confronted with an above-target inflation rate just as the euro zone's recovery is starting to look steadier on its feet. Economists see the ECB as reluctant to tighten credit until it is sure that a return of domestic demand, needed to sustain a full-fledged recovery, will not be tripped up by high energy prices or a slowdown in the euro zone's main trading partners. All 66 analysts in a poll last week predicted that the ECB would leave interest rates unchanged at 2.00 percent on Thursday. The interest rate announcement is due at 1145 GMT but no news conference to explain the decision is scheduled.
The ECB is focusing on the inflationary effects of rising oil prices but would be wrong to neglect the growth angle, said Robert Prior-Wandesforde, an economist at HSBC in London. "That is the bigger risk, that (rising oil prices) stop any domestic recovery in its tracks. They've been high enough for long enough to do some damage," he said. U.S. light sweet crude bounded to a fresh record high of $44.34 a barrel on Wednesday, the highest price since oil futures were launched on the New York Mercantile Exchange in 1983. IPE Brent in London also reached a new all time high at $40.99 per barrel. A slide in the euro-dollar exchange rate, which dipped below $1.20 on Wednesday, could compound the damage, as oil is priced in dollars. "We've seen the impact on inflation and that has had some impact on real disposable income growth. This may be one of the factors why German consumption seems to be lagging so much," said Silvia Pepino, an economist at JPMorgan in London. Euro zone inflation is running well above the ECB's two percent ceiling. It posted an annual 2.4 percent rise in July, the same as in June and only just below May's 2.5 percent rate. "High oil prices are a headwind. How much that will impact on the growth rate of private consumption going forward depends on how much they are going to rise further," Pepino said.
HIGH OIL PRICES, GROWTH DON'T MIX
Germany and the euro zone could be in for a double-whammy if the price of crude dampens activity in major trading partners. "The oil price is of course a concern. It could slow global economic growth," German Finance Minister Hans Eichel said on Wednesday, citing Germany's dependence on exports for growth. The euro zone's recovery so far has been led by strong exports to booming economies such as the United States and China. The hope that vigorous export business will spill over into the domestic economy has yet to materialise in large parts of the single currency bloc, such as Germany and Italy. HSBC's Prior-Wandesforde said some indicators, such as the OECD composite index, pointed to a slowing in the world's fast-growing economies that would cool the euro zone's export motor in the months ahead. "The industrial and export recovery will peak out towards the end of the third quarter, so you'll be losing that impetus before the domestic side has really got going," he said. The Organization for Economic Co-operation and Development's composite leading indicator for May rose in the euro area to 106.2 from 105.9, but the indicators for the United States and the OECD area as a whole declined. The euro zone needs to see more employment and income growth for the upswing to become self-sustaining, economists said. But the Eurozone Purchasing Managers' Index this week showed companies in both the manufacturing and service sectors were continuing to shed jobs in July, even as overall activity expanded. And jobless numbers in Germany, Europe's largest economy, rose for the sixth straight month in July to over 4.3 million, or an unemployment rate of 10.5 percent. Economists said job creation will take time and the ECB is likely to remain on hold for many months, even as the United States and Britain tighten credit. The Bank of England is seen raising rates 25 basis points to 4.75 percent on Thursday. The International Monetary Fund this week urged the ECB to keep interest rates steady until domestic demand takes hold. And there are some bright spots. French consumer spending surged 4.2 percent on the month in June, Pepino noted. "Oil prices have had some impact but not large enough to short-circuit the underlying improvement in private consumption," she said.///