Surging oil prices threaten to push up inflation and could undermine a strengthening recovery, the European Central Bank said today, as it decided to keep interest rates steady at 2.00 percent for a while longer.
While encouraged by improving economic performance in the 12-nation euro zone, ECB President Mr Jean-Claude Trichet trod a cautious line about the inflationary dangers from crude oil, which hit 21-year highs this week, and signalled that rates were on hold until the picture cleared.
"There are uncertainties and risks in both directions and that is why we have to be very vigilant," he told a news conference. "That is the reason why we keep our options open and that is they reason why we have no bias."
Yet oil creates a distinct problem and caused the ECB to raise its mid-point inflation forecast for this year to 2.1 per cent from 1.8 per cent, scuppering any chance of achieving its 2.0 per cent price stability goal for a fourth year.
Not until 2005 does it see price gains retreating to 1.7 per cent, compared with the 1.6 per cent it was forecasting just six months ago.
Mr Trichet welcomed the decision of OPEC ministers to raise oil production by about eight per cent, saying it "goes in the good direction."
But he stressed the main task for the ECB would be to ensure that oil costs, up 34 percent in the past six months to top $40 a barrel, did not feed through into higher wage settlements and final prices.
"The responsibility of the ECB is, in any case, to prevent second-round effects, which would make higher inflation a permanent feature which would prevent the delivery of price stability and which would hamper sustainable growth," he said.
By emphasising that price stability must remain the foremost concern of the central bank, analysts said Mr Trichet confirmed interest rates would remain on hold for many months.
"Trichet is having to walk a tight rope given that the bank's inflation target is now a bit of a joke," said Jon Lee, international strategist at Barclays Capital in London.
"He's skirting around the subject of what to do about rates."
European debt yields, jittery that Trichet would strike a more hawkish tone, retreated as they pushed back the timing of a rate hike.
The September Euribor future, a barometer of rate expectations, stood rose to 97.785 after Trichet's remarks from 97.775 earlier.