The European Central Bank (ECB) yesterday softened its anti-inflation rhetoric, increasing the likelihood that it will keep interest rates on hold over the coming months and raising the prospect of rate cuts.
In sharp contrast to recent hawkish statements, the ECB concluded in its August bulletin that the risks to price stability had "become more balanced".
Some economists said the marked shift in the Bank's tone raised the chances of a rate cut given the euro zone's sluggish economic recovery.
Just a month ago the ECB was insisting that medium-term inflation risks remained "tilted to the upside". Yesterday, while saying that inflation risks had diminished, the ECB signalled its mounting concern about the fragility of the euro zone's economic recovery.
It said the upturn remained likely to continue. But uncertainty surrounding the strength of the upswing was high because of financial market weakness.
The Bank underlined its pessimism by dropping its earlier prediction that the 12-nation bloc would be growing at its non-inflationary trend rate of 2-2.5 per cent by the end of the year.
The ECB's gloomier assessment of economic prospects came as the European Commission nudged down its forecast for third-quarter growth to 0.6-0.9 per cent, against an earlier estimate of 0.7-1 per cent.
The ECB said it continued to see inflation fluctuating around its 2 per cent target ceiling over coming months, with the stronger euro helping to keep prices in check.
But it warned that other factors did "not point to a moderation in longer-term price pressures", citing the threat from higher wage settlements, strong money supply growth and the rise in service industry prices.
Economists said the Bank's continuing concern over longer-term price pressures reduced the chances of any imminent rate cut, even though speculation has mounted that the ECB and US Federal Reserve might cut rates to boost confidence.
The monthly bulletin, which follows last week's decision by the ECB to keep rates unchanged at 3.25 per cent, was keenly awaited by markets as it provides one of the few guides over the summer break to the Bank's thinking.
Mr Austin Hughes, chief economist with IIB Bank, said the bulletin reflected the threat to the global recovery from weakness in US business.
"This is the silver lining out the economic cloud that's gathering," he said.
Weak US indicators, a softening of business sentiment in the euro zone and a rise in German unemployment tended to lessen inflationary pressures, he added.
While domestic price pressures remained an issue, this was offset by concern about the global upswing.
The fact that the bulletin was published after a "comprehensive review" underlined that concern. - (Financial Times Service)
