EURONOMICS Spain CPI, Oil Price Cast Doubt On ECB Target

By Robert S Duncan

11 April 2002

Dow Jones International News

Spanish inflationary pressures, coupled with the threat of rising oil prices, suggest the European Central Bank may have to acknowledge its 2% headline inflation target for the euro zone is unattainable.

Oil prices have been rising recently, fueled in part by the conflict in the Middle East, Iraq's suspension of exports and a strike by oil workers in Venezuela. In New York, prices have been as high as $28.00 a barrel.

Spain's national statistics institute, INE, Thursday said consumer price inflation in March was 0.8% on the month and, for the third month in a row, was 3.1% on the year. In February, prices rose 0.1% on the month. The figures were broadly in line with expectations.

At the same time, INE said Spain's European Union-harmonized consumer inflation was 0.9% on the month and 3.2% on the year. Underlying, or core, inflation was 3.5% on the year in March.

"The (ECB) 2% target is probably going to be missed again this year," said Kelly Tonkin, European economist at Lehman Bros. International in London. "In the first three months of the year there weren't any countries that were immune to inflationary pressures."

"Our take on the inflation, even before the oil (concerns), was that the ECB would miss the target. If the oil price spikes higher, then missing the target will be almost a certainty," Tonkin said.

Also out Thursday, Greece's inflation in March was 4.0% on the year, and non-EMU member Sweden's was 2.9% on the year.

All those figures are sharply higher than in Germany, where according to preliminary figures prices in March rose 0.2% on the month and 1.8% on the year.

David Brown, chief European economist at Bear Stearns International in London, said the ECB would have to look at the systematic spreads between different countries. "They're going to be very concerned about the high inflation in countries like Spain, Ireland and Holland," that will cause their 2% target to be overshot, he said.

Gwyn Hacche, senior European economist at HSBC in London, said while he does see inflation coming down in the higher-inflation countries, prices in the core economies will also have to drop before the euro-zone measure falls below the 2% target.

Spain's higher inflation rate is related to growth, according to Hacche. "In terms of GDP (gross domestic product) per head, Spain is still behind that of Germany and France. In a catch-up economy you'd expect inflation to be higher," he said.

   Economic Growth To Pick Up

While euro-zone headline inflation is seen dipping below 2% in May or June, the figure is expected to finish above that level by year-end.

"We have to accept now that the dip won't be as great as that we were expecting," said Bear Stearns' Brown.

That's in reference to concerns over rising oil prices. This effect could also be compounded by ongoing labor disputes throughout Europe, as various trade unions seek higher wages - all at a time when the euro-zone economy is showing signs of picking up speed.

Euro-zone GDP is seen growing 1% during the first three months of the year on an annualized basis, according to the median forecast of economists surveyed by Dow Jones Newswires. GDP is seen growing 2.4% during the second quarter, roughly the region's non-inflationary growth potential.

Even recent comments by ECB President Wim Duisenberg - and reiterated Thursday in the ECB's monthly bulletin - are being construed by economists to mean the 2% inflation target may not be attainable. The ECB has said interest rates in the euro zone are still appropriate to ensure price stability in the medium term, even though the recent rise in oil prices may pose some upward risk to inflation.

"At $25 per barrel, headline euro-zone inflation would probably fall below the ECB's 2% target; if oil prices reach $28 per barrel, then it will be touch-and-go for the 2% inflation target to be met," HSBC's Hacche said.

If oil goes above $28 a barrel, the ECB will be concerned and may move sooner to tighten its monetary policy, said Hacche.

The price of Brent blend futures at London's International Petroleum Exchange Thursday opened at $25.91/bbl, down slightly from Wednesday's close. The price is expected to edge towards the resistance level of $26.50.

"This is basically a whispering campaign for the ECB, in terms of talking, hinting at an implied bias toward an upward inflationary risk," said Bear Stearns' Brown. "The (ECB) easing policy has definitely come to an end...and switched to neutral."

Market consensus sees the U.S. Federal Reserve tightening its monetary policy around June 26, said Brown, meaning that a like move by the ECB could happen in the fourth quarter, since there is about a five- to six-month time lag between the European and U.S. economies.

Brown additionally noted the money market is already discounting an ECB rate tightening of 75 basis points.

But Lehman Brothers' Tonkin is even more hawkish.

"We think the ECB will raise rates by 50 basis points in two months," around June, said Tonkin. "We suspect the European banks will raise rates before the Fed," with the Bank of England raising rates by 25 basis points.

Hacche noted the different approaches taken by central banks, with oil price hikes seen in the U.S. and U.K. as dis-inflationary, causing real economies to slow. "The ECB, however, they seem to have a greater concern for headline inflation," he said.