Market expectations that the European Central Bank will cut interest rates fail to consider the dangers of higher inflation, ECB Governing Council member Axel Weber said today.
Euro zone inflation is unlikely to fall back to its target of below 2 per cent in 2008 and the ECB's December forecast of 1.8 per cent inflation in 2009 is likely to prove too low due to record oil prices, the German Bundesbank president said.
By contrast, the German economy is solid and the euro zone economy is only likely to slow to just below its long-term potential rate this year, Mr Weber said.
"Against this backdrop ... the current dominant market consensus on interest rate expectations clearly underestimates the inflation risks. These expectations do not drive the monetary policy view of a central bank which is committed to price stability," he said.
Most economists expect the ECB to cut rates from their current 4 per cent by the end of June at the latest, according to a Reuters poll published on February 19th. The euro briefly extended gains towards earlier record highs today against the US dollar after Mr Weber's remarks.
Mr Weber did not address the euro's strength in his speech to top politicians from Germany's ruling coalition of conservatives and social democrats, and declined to comment on the subject to reporters at the event.
"It's another confirmation that the ECB is not ready to cut rates," said Niels Christensen, FX strategist at Nordea in Copenhagen. "They are still worried about the inflation outlook and this view is supported by strong German data."
Mr Weber said above-inflation wage deals threatened to entrench the current record inflation rate of 3.2 per cent and the ECB would take action if long-term inflation expectations seemed to be rising significantly.
"If we see a marked upward trend that would be a clear signal for us to take action on interest rates, he said.
After its March 6th policy meeting the ECB is expected to publish an update to its December staff economic projections which forecast growth of around 2 percent and inflation of about 2.5 percent in 2008.