Eurozone warned on impact of credit crisis

The global financial turmoil could last longer and have a broader impact on the eurozone economy than previously expected, the European Central Bank warned onThursday, even as it underlined its hard-line stance on inflation by leaving interest rates unchanged.

Comments by Jean-Claude Trichet, ECB president, highlighted the risks and uncertainty the Frankfurt-based institution sees surrounding the eurozone economic outlook. But with inflation at 3.5 per cent, the highest for almost 16 years, his tone after the ECB’s latest interest rate meeting suggested little chance of an early cut in borrowing costs, analysts said.

“It is a central bank particularly uncomfortable with the inflation rate, but there is no way that they can hike rates at the moment, so they stay where they are,” said Erik Nielsen at Goldman Sachs.

So far the ECB has left its main interest rate at 4 per cent since last June – in spite of hefty cuts by the US Federal Reserve. Financial markets continue to believe that the ECB will not cut until September.

Describing the surge in inflation as “rather protracted” but a temporary result of higher energy and food costs, Mr Trichet warned again about the dangers of generous wage deals. Such “second round” effects had led to mass unemployment during oil shocks in the past, he said. Unlike the Fed, the ECB’s sole focus is on inflation.

US trade deficit widens

The US trade deficit widened to $62.3bn (€39bn, £31.3bn) in February, as a jump in imports offset the latest strong showing by exporters, James Politi reports from Washington.
The figures ran contrary to economists’ expectations of a narrowing of the trade deficit from $59bn to $57.5bn, as the weak dollar drove exports and a slowing domestic economy had an impact on demand for imports.
Goldman Sachs said the figures “remove some upside risk” to their forecast of a 0.5 per cent contraction in the US economy in the first quarter.
A 3.1 per cent jump in imports to a high of $213.7bn was led by purchases of consumer goods and cars, while the 2 per cent rise in exports, also to a record, was driven by the manufacturing and agricultural sectors.

Mr Trichet stopped short of outright condemnation of a recent German public sector wage deal, which economists warned could be inflationary. Eurozone inflation was forecast to fall back within the ECB’s target of an annual rate “below but close” to 2 per cent, over the next 18 months, he said.

The ECB has yet to see signs of a dramatic slowdown in economic growth, which would help ease inflation pressures. Growth in the first quarter could have been surprisingly strong, especially in Germany, economist believe.

Mr Trichet said the eurozone’s economic fundamentals were “sound” and without the imbalances seen in the US, while incoming data still pointed to moderate growth.

But “downside risks” prevailed, Mr Trichet said, and were related mainly to financial market turmoil, “which could last longer than initially thought and could have a broader than currently expected impact on the real economy”.

He suggested that his comments reflected markets’ assessment of conditions. The ECB president described himself as no more worried about the financial market turbulence than he was last August.

Mr Trichet indicated that the ECB remained committed to using liquidity-boosting operations to ease market tensions, although he announced no new measures on Thursday. But he rejected firmly proposals floated at some other central banks for the mass purchase of mortgage-backed securities as a possible solution to the credit crisis.

The ECB saw “no significant signs of supply constraints on bank loans” as a result of the credit squeeze, but the exceptional strength of eurozone lending to business appeared to have become more puzzling for the bank. Latest figures showed the annual growth accelerating to a record 14.8 per cent in February.

Mr Trichet suggested special factors might have been at work if, for instance, companies had been drawing down on credit lines or had switched from raising funds in capital markets.

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