ANALYSIS: ECB rate hikes to end as inflation peaks, economy slows

Aug 31, 2011, 12:12 GMT

Berlin - Hopes that inflation might have peaked, combined with high unemployment and slowing economic growth, could lead the European Central Bank's (ECB) to reverse its recent rate hikes in the coming months.

Annual inflation in the 17-member eurozone held steady at 2.5 per cent in August after posting a surprise fall in July, the European Union's statistics office Eurostat said Wednesday. It is also lower than the 2.8 per cent it reached earlier this year.

At the same time, unemployment in the currency bloc remained stuck at 10 per cent for the third consecutive month amid signs that slowing growth had hit hiring across the region.

The release of the economic indicators forms part of the buildup to the September 8 meeting of the ECB's 23-head rate-setting council.

But since the ECB met a month ago, global share markets have been engulfed by a major shakeout that has wiped billions off the value of stocks.

This followed moves by investors to scale back their growth outlook as they fretted about the debt crisis in both the eurozone and the US.

Economic confidence in the eurozone during August posted its biggest fall since the 2008 financial crisis, the European Commission's closely watched survey released Tuesday showed.

After delivering two hikes in borrowing costs this year to head off a resurgence in inflation, interest rates in the eurozone currently stand at 1.5 per cent.

Many analysts had up until recently thought that the ECB would follow up these rate rises by raising its benchmark refinancing rate by a further 25 basis points in October.

But the weaker economic outlook has raised doubts among analysts as to whether the Frankfurt-based ECB will be able to forge ahead with further increases in borrowing costs this year.

Wednesday's data would 'reinforce the case for the ECB to drop its tightening bias at next week's policy meeting and tone down the rhetoric on inflation risks,' said ING Bank economist Martin van Vliet.

Some analysts even believe that the downbeat economic outlook means that the ECB will eventually be forced to reverse the two rate rises it has delivered this year.

'The news that eurozone core inflation remained very low in August while unemployment rose further in July should reduce any remaining inflation fears at the ECB, adding to expectations of possible future interest rate cuts,' said Jennifer McKeown, senior European economist at the research group Capital Economics.

Still, inflation remains above the ECB's target of consumer prices coming in at below but close to 2 per cent.

Analysts also warn that high food prices means it might take until next year before inflation falls below the ECB's 2-per-cent ceiling.

This is despite signs that inflationary pressures have eased in recent months as a result of lower energy costs and the slowdown in global economic growth.

If the ECB planned another rate hike in October, ECB chief Jean-Claude Trichet would be expected to signal such a step at the press conference following next week's governing council meeting.

Either way, Trichet's press conference is likely to be dominated again by questions about the economic risks posed by the eurozone's ongoing debt crisis and slowing global growth.

After chalking up a solid 0.8-per-cent expansion rate the first quarter of the year, the eurozone economy slowed to 0.2 per cent growth in the three months through June 30, Eurostat said this month.

On Wednesday, Eurostat said another 61,000 people joined the job queues across the currency bloc in July. This pushed the total numbers out of work up to 15.757 million.

In the meantime, the European Commission's Economic Sentiment Indicator (ESI) for the eurozone plunged from 103.2 in July to a lower-than-forecast 98.3 this month. The indicator now stands at its lowest level in more than year.

The ESI's monthly decline represented its biggest fall since the world financial crisis took hold in December 2008. Analysts had predicted that the indicator would drop to 100.8 in August.

Particularly worrying for Europe's economic growth outlook was the slump in the ESI for Germany from 112.7 to 107.0. Up until now, Germany has been Europe's main engine of growth.

The fall in the ESI followed declines in sentiment across the board - in both the industrial service sectors. In addition, consumer sentiment posted its biggest drop in more than two decades.