Trichet cautions about risk of inflation 'exploding'

European Central Bank President Jean-Claude Trichet said there is a risk of inflation "exploding" if central banks do not act decisively.

"We, central banks, have a big responsibility," Trichet told Germany's Die Zeit newspaper. "If we're not decisive, there's a risk of inflation exploding. If we act in a decisive way, we can master the situation." The ECB confirmed the comments, which were made on June 23 for an article to appear today.

Trichet said on June 5 the bank may raise its key rate by a quarter-point to 4.25 per cent at its meeting today to contain inflation even as economic growth slows. Since then, soaring food and energy prices pushed euro-area inflation to four per cent, twice the ECB's limit. Policymakers are concerned that workers will demand wage increases to compensate for the higher cost of living, entrenching faster inflation.

"Trichet's comments reflect the ECB's position that it will counter any wage inflation spiral emanating from current inflation rates," said Stefan Bielmeier, an economist at Deutsche Bank in Frankfurt. "The ECB's thinking is that even though higher rates may hurt growth in the short term, the longer-term economic fallout would be much worse if it doesn't act now."

Analysts, meanwhile, have begun to ask whether insatiable inflation could push borrowing costs even higher in the months to come.

"A 25 basis point rate increase looks virtually like a done deal," Bank of America senior economist Holger Schmieding said.

European politicians, French President Nicolas Sarkozy, Spanish Prime Minister Jose Luis Rodriguez Zapatero and German Finance Minister Peer Steinbrueck, have pressed the ECB to think about the impact that higher lending rates will have on business activity and consumer sentiment.

"The ECB should take into account the consequences of an interest rate hike," Steinbrueck said, having earlier warned that a rate increase "could reinforce an economic slowdown".

Sarkozy said: "I think the ECB, whose independence must be preserved, should ask itself about growth in Europe and not simply inflation." Zapatero over the weekend urged the ECB to show "flexibility" in its monetary policy.