The European Central Bank held interest rates steady for a 12th month as expected on Thursday, taking more time to gauge whether soaring oil prices will boost inflation significantly or derail economic growth.
Politicians and business leaders are voicing concern that surging oil prices — U.S. crude oil futures hit a 21-year high of $42.45 on Wednesday — will rob consumers of money they would have spent buying products and services, hurting recovery.
But ECB President Jean-Claude Trichet said at a news conference on the bank’s decision to keep its benchmark refinancing rate at 2.00 percent that while high oil prices pose a downside risk, he expects price pressures to remain relatively contained as he gave a positive reading on growth.
“The economic recovery has strengthened over recent months,” Trichet said in an opening statement.
“We have also witnessed stronger inflationary pressures over the short term. Nevertheless, we are still of the view that the medium-term outlook remains in line with price stability.”
Given the improving outlook, ECB staff have revised slightly the bank’s growth forecasts for this year to a 1.4-2.0 percent range from 1.1-2.1 percent.
OPEC ministers agreed Thursday to raise oil production to relieve price pressures. This should bring some relief from pressures for a monetary response to the new threat.
Analysts were anxious to hear how grave an inflationary threat the ECB saw in oil prices since most economists currently expect no rate hike before next year when the slow-moving recovery is firmly established.
“The recovery is still too fragile to support higher interest rates, so in fact there is a situation where risks to growth are probably still on the downside, while there may be first indications of inflation risks on the upside,” said Julian von Landesberger, economist at HVB in Munich.
No danger yet
Oil price gains linked to Middle East violence have grabbed headlines but have yet to disrupt the ECB’s forecast for gradual economic recovery and subdued inflation, analysts said.
The 30 percent rise in crude oil costs so far this year is also fuelling price pressures in the euro zone, with annual inflation in May jumping to 2.5 percent from 2.0 percent in April. The ECB aims to keep inflation below two percent — a goal it was near to reaching before the oil spurt and it may be forced to raise its 2004 inflation forecasts.
“Oil prices are a risk for inflation but they are also a risk for growth so it is not affecting ECB decision making in the short term,” said Reijo Heiskanen, a senior analyst at Nordea in Helsinki.
Indeed, the Reuters Purchasing Managers’ Index for the massive service sector on Thursday showed a strengthening of the euro zone recovery in May despite the oil price shock. Business activity expanded for an 11th month to 55.8 while employment improved. The PMI manufacturing survey for May also hit its highest level in over three years.
The ECB response to the double-edged threat that oil poses to growth and inflation has so far been calm but not indifferent.
Trichet noted last week that the rise in oil prices had not changed the central bank’s economic assessment at its May meeting. The ECB says it is monitoring carefully developments that could affect the inflation outlook.
Separately, ECB Council members Klaus Liebscher from Austria and Jaime Caruana from Spain said it was too early to conclude that the oil price rise would prompt a change in the outlook.
Analysts said there is little monetary policy can do to offset short-term damage from costly oil because of the long time lag between an interest rate move and its effect on the real economy. But the ECB will need to be firm if businesses and unions try to raise prices and wages in response to dear oil.