The ECB's decision to boost the euro by increasing interest rates had only a brief effect yesterday as warnings the move could undermine economic recovery in France and Germany cut short the currency's turnaround.
Although the euro enjoyed an initial bounce, following the ECB increase, it soon fell back to $0.8860, on foot of the warnings. It recovered only slightly in late trading, despite an extremely weak purchasing managers' index in the US which would normally have led to dollar selling.
The ECB's sixth increase in 10 months will also mean higher repayments for Irish homeowners. This will feed through to the Consumer Price Index while a further slide in the euro will also boost imports as prices rise again.
Yesterday, the ECB pointed to the euro's slide and higher oil prices as the main causes for a pick-up in prices. The ECB said it will "remain alert to emerging inflation risks", an indication that rates may rise further. Mr Jim Power, chief economist at Bank of Ireland, believes the ECB will raise rates again next month.
The ECB's anti-inflation crusade is counter-productive," said Mr Gustav-Adolf Horn, chief economist of the German DIW Institute. The ECB is obviously focused on supporting the euro. That strategy can't work as it also weakens growth and therefore hurts, rather than strengthens, the euro." Data released yesterday showed unemployment in France rose for the first time in 11 months, to 9.7 per cent in July from 9.6 per cent. Another report showed industrial production fell 0.6 per cent in June, the biggest monthly decline since December. Germany's IFO research institute reported last week that business confidence in July fell to the lowest level in eight months
The central bank has rejected suggestions that rates are at a level that risks throttling economic growth. "The euro area has entered a period of strong growth," the ECB said yesterday.
The euro's weakness is also partly responsible for the inflationary pressures the ECB is attempting to dampen. The cost of imported goods, particularly from the US and the UK, has risen because of the euro's weakness as dollar-denominated oil prices have tripled in the last 18 months. Euro zone inflation reached 2.4 per cent in July, well in excess of the ECB's 2 per cent ceiling for a second month in a row.
According to Mr Austin Hughes, chief economist at Irish Intercontinental Bank, the rise will add to inflationary pressures as higher mortgage costs feed into the Consumer Price Index. The latest ECB increase came at the same time as confirmation that credit growth and mortgage lending are slowing slightly. Private sector credit grew by 21.9 per cent in July after increasing to 24.3 per cent in June.
Mortgage lending also fell back to 17.6 per cent from 19.7 per cent the previous month.
The ECB will be hoping that the latest rate rise will eventually feed into a higher euro by narrowing the gap between European and US interest rates to 2 percentage points from 2.5 percentage points at the start of the year. ECB officials hope that the narrowing differential will lure more investment in euros.
