European central bankers (ECB) stressed the need to keep a close eye on price pressures as figures from Germany on Thursday showed producer price inflation jumped above 5% last month.
ECB policymaker Lorenzo Bini Smaghi said exiting an accommodative monetary policy too late can sow the seeds of future imbalances.
Bini Smaghi, a member of the ECB’s executive board, added that focusing on core inflation, a measure that strips out volatile energy and food prices, can give policymakers a “downwardly biased assessment of overall price pressures”.
The Italian spoke in Milan late on Wednesday, when fellow ECB board member Juergen Stark said separately that the ECB was watching inflation developments very closely, but that in the medium term it remained in line with the bank’s target.
ECB governing council member Erkki Liikanen added to the chorus, saying the situation must be monitored closely..
“There is no imminent price pressure, but they are concerned, and they are more concerned than the Fed,” said Deutsche Bank economist Gilles Moec. “They can see pressure building right now.”
A survey of German investors showed half expect higher interest rates by July, a few months earlier than markets are currently pricing in.
Euro zone inflation last month exceeded the ECB’s goal of close to, but below 2%, for the first time in two years.
The extent of upward pressure on headline inflation will be determined by the capacity of businesses to pass on the increased costs to their customers.
A robust economic climate in Germany means producers will likely feel they can pass on more costs, although historically there has been a limited pass-through from PPI to consumer inflation.
“In Germany . . . consumers are stronger than they were a year or two ago, so pricing power of retailing companies is probably higher,” said Moec, though he did not think headline inflation would go as high as 4 or 5 %.
“Even if we don’t get there, the overall inflationary pressures are clearer than they were six months ago and are clearer in Europe than they are in the US,” Moec said.
The acceleration in euro zone inflation in December, when it hit 2,2 %, was largely driven by energy price rises, a development that has sparked a debate about whether the ECB should focus on core inflation.
“Core inflation . . . can give misleading signals in the event of persistent changes to relative prices,” Bini Smaghi said.
“Monetary policies aimed at fine-tuning short-term objectives . . . run a serious risk that they will induce too much policy forbearance for too long,” he said.
“Exiting an extraordinarily accommodative mode too late can sow the seeds of future imbalances,” he said.
Analysts said the ECB was wise not to look at core inflation too carefully.
“If it (the commodity price increase) is more of a structural thing, it doesn’t make any sense to look at core inflation and ignore that,” said Nomura economist Laurent Bilke.
After the ECB left rates on hold last week, Trichet made a point of harking back to 2008 when the ECB hiked rates just before the Lehman bankruptcy that tipped the global financial system into full-blown crisisa suggestion perhaps that policy could be tightened this time if inflation takes off, regardless of the status of the euro zone debt crisis.
Stark said the rise in euro zone inflation last month was not a reason for immediate alarm but said the situation needed to be monitored very closely and warned that the balance of risks could shift quickly.
“The ECB sees in the near-term higher inflation but our medium-term assessment remains unchanged,” he said.