The European Central Bank said inflation remains its primary concern even after oil prices dropped and the economy contracted.
Inflation risks are still on the "upside," the Frankfurt-based ECB said in its monthly bulletin today. Vice President Lucas Papademos said in Hamburg the bank will "do what's necessary to preserve price stability,'' and council member Yves Mersch said in Luxembourg that "while oil prices have declined, past increases could still trigger a wage-price spiral."
While the price of oil has dropped almost a third since its July record, it is still over 60 percent higher than two years ago.
The ECB is worried that higher energy costs will prompt companies to raise prices and workers to demand higher wages to compensate for the increase in the cost of living.
At the same time, the euro-area economy is struggling to recover from a second-quarter contraction.
Papademos said the slowdown has been "more marked and abrupt than previously expected," and Mr Mersch said "growth in the quarters to come will be modest".
Still, the ECB also expects a "gradual recovery", according to today's bulletin. Inflation is running at 3.8 per cent, almost twice the bank's 2 per cent limit.
The ECB raised its key rate to a seven-year high of 4.25 per cent in July after inflation quickened to the fastest pace in 16 years. The inflation risks identified then "remain today", Mr Mersch said.
He and Papademos reiterated that the bank's current monetary policy stance will contribute to achieving price stability, signaling policy makers are in no rush to lower interest rates.
The ECB raised its inflation projections last week to around 3.5 per cent for 2008 and 2.6 per cent for 2009. Mr Mersch said he doesn't expect inflation to "return to levels that are in line with the definition of price stability until about 2010".
At the same time, ECB staff lowered their growth forecasts for this year and next to about 1.4 per cent and 1.2 per cent respectively.
Bloomberg