Euro zone inflation hits new high

 
 
Euro zone inflation hit an all-time high in January and economic sentiment plunged to two-year lows, data showed, raising the spectre of stagflation and deepening the European Central Bank's policy dilemma.

"Euro zone economic data has stagflation written all over it right now," said Bear Stearns European Economist David Brown.

The European Union's statistics office estimated that inflation in the 15 countries using the euro rose to 3.2 per cent year-on-year in January, the highest reading since measurements for the single currency area began in January 1997.

Economists had expected inflation to remain at 3.1 per cent, as in December and November.

No monthly data or detailed breakdown was available with the Eurostat estimate, but economists said the consumer price index was most likely again boosted by food and oil prices.

This was confirmed by Spanish data earlier on Thursday, which showed prices rose at their fastest rate on record in January due to higher food and utility bills. Belgian inflation was driven to 16 year highs by the same factors.

While economists expect inflation to slow down later this year, some said it could get worse before it gets better.

"Inflation could edge higher in the coming months, peaking at 3.3 per cent in February/March," said Sunil Kapadia, European economist at UBS.

The ECB wants to keep inflation just below 2 per cent over the medium-term, but has refrained from raising rates from the current 4 per cent because of signs that the economy is slowing.

With inflation at a record high it is equally difficult for the bank to cut rates, though economists noted that in May 2001, when inflation was at 3.1 per cent and consumer inflation expectations higher than now, the ECB did cut rates.

Inflation expectations among businesses, measured by a European Commission's monthly survey, showed a slight increase to 14 points from 13 in December. But inflation expectations among consumers were stable for the third month in a row at 28 -- lower than the 33 points when rates were cut in May 2001.

Most economists believe therefore that the bank will have to cut rates later this year, following the example of the US Federal Reserve, to support euro zone expansion.

 
Economy Slowing

The Commission survey showed economic sentiment tumbled to 101.7 points -- its lowest reading since the start of 2006 --  from a downwardly revised 103.4 in December and 104.1 in November, also revised down. The reading was a long way below market expectations of 104.0.

"This is further confirmation that economy has entered a period of non-negligible softness, with private consumption unable to offset the slowdown in investment and the drag of net exports," said Aurelio Maccario, economist at Unicredit.

He expects fourth quarter euro zone growth slowed to 0.3 per cent quarter-on-quarter from 0.8 percent growth in the third.

All components of the sentiment indicator fell, with consumer and retail sector confidence taking the biggest hit.

Confidence among consumers sagged to -12 from -9 points even though data showed that December unemployment in the euro zone was unchanged at record lows of 7.2 per cent of the workforce.

Unemployment fell in the euro zone's two biggest economies -- Germany and France -- and was lower than expected in Germany in January, but economists said the improvement would soon come to an end because of slower economic growth and wage demands.

With pay negotiations under way in Germany, the tightening labour market could also start a wage growth-inflation spiral -- a phenomenon the ECB is keen to avoid.

Yet despite the fewer unemployed, German and French consumer confidence tumbled in January and German retail sales fell 1.4 per cent in the last quarter of 2007.

Economists said the weakness in German consumer demand could be offset by business investment and healthy exports, but the German Finance Ministry said that while the economy was "robust", exports could be hit if the euro appreciated more.

The euro's strength, following the Fed rate cuts also worried French Europe Minister Jean-Pierre Jouyet and the Chairman of euro zone finance ministers Jean-Claude Juncker.

Speaking in Paris, Juncker said that if interest rates on both sides of the Atlantic diverged even more, the euro could rise to levels "more and more difficult" for euro zone firms. (Reuters)

 
 
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