Saturday, January 5, 2008

Trichet Says Market Tensions Receding, ECB `Ready' (Update1)

By Christian Vits

Jan. 5 (Bloomberg) -- European Central Bank President Jean- Claude Trichet said financial-market tensions are receding and the bank remains committed to fighting inflation.

``Tensions have receded while remaining significant,'' Trichet said today in a speech at a party convention of Germany's Christian Democratic Union in Wiesbaden, near Frankfurt. ``The ECB's Governing Council stands ready to counter upside risks to price stability, in line with its mandate.''

The ECB shelved a planned rate increase in September to assess the economic impact of the U.S. housing slump, which made banks reluctant to lend and pushed up credit costs. At the same time, euro-region inflation has accelerated to the fastest pace in more than six years, prompting some ECB council members to call for a rate increase.

ECB policy makers convene in Frankfurt on Jan. 10 to decide again on interest rates. Trichet stressed that his comments today should not be ``interpreted in terms of our future decision next Thursday.''

On Dec. 6, the bank left its benchmark interest rate at 4 percent, with Trichet acknowledging that some council members wanted to raise borrowing costs. Inflation, which the ECB aims to keep just below 2 percent, held at 3.1 percent in December.

The recent ``substantial increase'' in oil and food prices ``are having a strong upward impact on inflation,'' Trichet said, adding the economy faces a ``more protracted'' period of elevated inflation than previously expected.

Wage Increases

The ECB is concerned that so-called second-round effects, such as bigger wage increases, will cause a price spiral. In Germany, workers are already seeking more pay to compensate for higher costs. The Ver.di labor union is demanding 8 percent more pay for some 2.27 million workers, it said Dec. 20.

The ECB predicts inflation will average about 2.5 percent this year after 2.1 percent in 2007.

Risks to the outlook for economic growth ``lie on the downside,'' Trichet said, referring to a ``high level of uncertainty'' due to the recent financial market volatility.

Borrowing costs jumped in August as banks began to reveal losses on securities linked to U.S. mortgages aimed at people with poor credit histories, causing lenders to hoard cash. Losses from U.S. subprime mortgage foreclosures will probably reach $300 billion, the Organization for Economic Cooperation and Development predicted on Nov. 22.


The Fed has lowered its benchmark rate three times to 4.25 percent since September to shore up the world's largest economy. Traders increased bets this past week that the Fed will cut its key rate by another half-point this month after industry surveys showed manufacturing slumped to the lowest level in almost five years in December and unemployment jumped to a two-year high.

``Uncertainty surrounding the financial stability outlook for the euro area has heightened and may persist,'' until the effects of the turbulence on financial institutions will be visible, Trichet said. Still, ``there are mitigating factors, including a broadly favorable economic outlook.''

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