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Latest update : 2008-03-19

Financial market turmoil is worse than earlier thought and the euro zone is unlikely to escape unscathed, European Central Bank policymakers said on Wednesday.

LUXEMBOURG/PARIS, March 19 (Reuters) - Financial market turmoil is worse than earlier thought and the euro zone is unlikely to escape unscathed, European Central Bank policymakers said on Wednesday.


But central bankers also worried about inflationary pressures caused by high commodity prices even as economic growth slows, confirming what analysts said points to a split within the ECB's decision-making Governing Council.


The contrast between slowing growth and stubborn inflation is a dilemma for the ECB, which has kept interest rates on hold at 4 percent despite other major central banks easing policy, including the U.S. Federal Reserve which slashed rates by three-quarters of a percentage point to 2.25 percent on Tuesday.


In separate comments on Wednesday, Belgium's Guy Quaden and Luxembourg's Yves Mersch said the euro zone economy was not immune to the slowdown in the United States and would also be scarred by the financial market turmoil.


Both also expressed concern about recent volatility on currency markets, which propelled the euro to a record high against the U.S. dollar on Monday .


"As regards the impact on the economic activity of the fall-out of the U.S. housing market problems ... that proves to be more severe and more protracted than initially assumed," Mersch told an ALFI fund industry summit in Luxembourg.


"The euro area and Luxembourg can hardly escape the ripple effects of slowing U.S. demand and possibly exchange rate turmoil."


Quaden echoed those comments shortly afterwards in Brussels, describing recent moves on currency markets as "excessive".


"The crisis in the financial sector in the U.S. is more profound and probably more durable than initially foreseen, and it has negative consequences for the economic activity in the U.S.," news agency Market News International quoted him as saying.


"Having said that, I also note that the European economy and the Belgian economy seem to be much more resilient than would have been the case in the past, but I may not say that they are immune to the developments in the financial markets and the economic developments in the U.S." 


The latest comments contrast with a firm focus on inflation risks from Germany's Axel Weber and Executive Board member Juergen Stark, as well as France's Christian Noyer. 


"Basically, the whole message keeps stressing the divide within the council," said Unicredit economist Aurelio Maccario.


"Some stress price stability, and now Mersch and Quaden come out with a similar message that euro zone growth is at risk."




In a speech released in Paris, Noyer said inflation was a major concern in the euro zone.


"There is a clear upward bias to risks regarding inflation, which has to be taken into account by economic policy," he said.


Inflation expectations need to be anchored as rising costs were generating price pressures, Noyer said.


Quaden also expressed worries about price stability, and said the latest inflation data -- showing inflation at a record peak of 3.3 percent in February -- was "not good".


The ECB has a mandate to keep inflation below, but close to two percent, but it has failed to keep prices rising at that rate for eight years running and is set to fail again this year as strong demand has lifted prices of many commodities to record levels.


Noyer sees inflation falling below 2 percent in a few months due to global slowdown and moderating commodity prices, he said.


ECB staff raised inflation forecasts this month for both 2008 and 2009 due to high fuel and food prices, averaging 2.9 percent this year before falling to 2.1 percent in 2009.


Noyer also warned of the risk of a wage-price spiral, but added significant second-round effects have yet to materialise in the common currency area.


But Unicredit's Maccario said he expected the ECB to move more to the dovish side on interest rates as inflation trends lower. 

Date created : 2008-03-19