ECB Warns of Inflationary Pressures Amid Rising Oil Prices

European Central Bank policymakers yesterday cautioned against generating inflationary pressures in the eurozone by driving up wage settlements on the back of higher oil prices. The warnings, led by Bundesbank president Axel Weber, suggested that the ECB may raise interest rates if the temporary rise in inflation feeds through into higher wage settlements. ECB officials emphasized the need for vigilance in monitoring inflation expectations and warned that a wage-price spiral could be triggered if workers demand higher wages in response to rising oil prices. The comments follow similar warnings from ECB president Jean-Claude Trichet and chief economist Ottmar Issing, who have stressed the importance of keeping wage demands in check to maintain subdued inflationary pressures.

Key Takeaways:

• ECB policymakers warned that companies and workers should not drive up wage settlements on the back of higher oil prices, as this could generate inflationary pressures in the eurozone.
• Axel Weber, Bundesbank president and ECB council member, stated that it would be a "worrisome development" if higher inflation expectations led to "second round effects" such as rising wages.
• Weber emphasized that the ECB would have to review its policy assumptions if wage settlements fed through into higher inflation, leading to a more restrictive approach to monetary policymaking.
• ECB president Jean-Claude Trichet appealed to social partners to avoid an inflationary spiral, stating that price pressures would ease if wage demands were held down.
• Trichet's comments follow warnings from Ottmar Issing, the bank's chief economist, that higher indirect taxes and oil prices were "one-off effects" that should not be compensated for through higher wages.
• Economists expect the ECB to start raising interest rates in the first quarter of next year, with financial markets pricing in a quarter-point rate rise by the turn of the year.
• ECB executive board member Gertrude Tumpel-Gugerell left all options open, while Julian Callow of Barclays Capital stated that risks to ECB rates are firmly skewed on the upside over the next 12 months.

Statistics:

• Inflation rate in the eurozone reached 2.5% in May, well above the ECB's "below but close to 2%" target.
• ECB policymakers expect the recent jump in inflation to be temporary, but emphasized the need for vigilance in monitoring inflation expectations.
• Financial markets are pricing in a quarter-point rate rise by the turn of the year, with economists expecting the ECB to start raising interest rates in the first quarter of next year.

Sources:

• "ECB signals rate hike fears as oil price rise sparks inflation alarm," Daniel Dombey and Tony Major, Financial Times, June [no date specified].
• "ECB executive board member Gertrude Tumpel-Gugerell", Jonathan Hoffman, RBS Financial Markets, June [no date specified].
• "ECB warns of inflation risks as oil prices surge," Daniel Dombey, Financial Times, June [no date specified].