ECB's rhetoric on inflation in focus

[March 03, 2011]  FRANKFURT, Germany (AP) -- The European Central Bank's rhetoric on inflation is in focus as the bank meets Thursday to set interest rates, with markets watching for any shift in message that could pave the way for a rate hike sooner than expected.

The ECB's key refinancing rate has stood at a record-low 1 percent since May 2009. So far, markets are pricing in a first rate increase toward the end of this year, even though inflation is running above the bank's target.

Recent public statements from top ECB officials have stressed that inflationary pressures are increasing in Europe as growth picks up in Germany and prices for food, raw materials and oil rise around the world. Sharply higher oil prices due to turmoil in the Arab world have intensified those worries.

The question now is whether bank President Jean-Claude Trichet will officially shift the bank's rhetoric from a Feb. 14 assessment that inflation risks are "balanced." That may lead markets to adjust their expectations of when rates will rise.

Inflation has recently been running ahead of the bank's fiercely guarded goal of less than but close to 2 percent a year. It hit 2.4 percent in February for the countries that use the euro, up from 2.3 percent in January.

Central banks typically raise interest rates as economies grow out of recession to prevent inflation. The timing can be tricky because increases that come too soon can stunt the recovery by raising borrowing costs for businesses and consumers.

Another factor complicating the bank's calculations is the 17-nation eurozone's two-speed recovery.

Germany's economy is showing healthy growth but smaller countries on the periphery, such as Greece and Portugal, face lagging output at a time their governments are trying to get a handle on their borrowings. Rates that are too low for Germany might be too high for those countries.

While attention this year has centered on the ECB's stance on inflation, there also is growing market speculation that the bank may say something Thursday about how it intends to get Europe's wobbly banks weaned off emergency credits, particularly its unlimited three-month handouts.

The ECB has twice indicated it wanted to end that measure, only to back off as Europe's government debt crisis flared.

The bank has had to play a pivotal role in keeping Europe's banking system afloat since the financial crisis exploded in the summer of 2007.

[Associated Press]

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