The European Central Bank has expressed heightened concern about inflation risks from surging oil prices, but gave no sign it plans to tighten credit any time soon.
Inflation is likely to hold above the ECB's 2 per cent ceiling for the rest of this year and the early months of 2005 if oil prices stay at high levels as markets expect, the central bank said in its August monthly bulletin.
But with the recovery broadening only gradually, analysts said the ECB is showing it feels no pressure to follow other major central banks in ending the era of record low interest rates in the 12-nation euro zone.
The August bulletin is a first look into ECB thinking following its August 5th policy discussion after which it left interest rates unchanged at their historic 2 per cent low for the 14th month in a row, but held no press conference.
As long as higher oil costs do not spill over into higher wages and general prices, analysts said the central bank can delay any monetary tightening until recovery is solid.
"The risk is that the longer inflation stays above 2 per cent, the risk of second-round effects increases a little bit," said Rainer Guntermann, an economist at DKW in Frankfurt.
"But for fundamental inflationary pressure to happen, we would need to see investment and domestic consumption pick up," he said.
"And we don't see that," he added.
Indeed, the ECB said it expects price stability, defined as an inflation rate below but close to 2 per cent, to return next year despite current pressure from oil and indirect taxes.
"Looking further ahead, there are no indications as yet of a build-up of stronger general inflationary pressures," it said in the bulletin.
Domestic price pressures should stay limited as long as pay rises remain moderate as recent data indicated.
An expected rise in productivity should also lower labour costs, the ECB said.
However, the ECB also cited potential inflation risks from oil prices, indirect taxes, and possible wage and price hikes.
"Concerns relate, in particular, to the continued high level of oil prices, which may be sustained by the strength of global economic growth," the ECB said.
The ECB said it would remain vigilant on inflation risks and inflation expectations, which had risen somewhat for the near term on the back of higher oil and commodity prices.
Its Survey of Professional Forecasters for the third quarter showed expected inflation for this year rising to 2.1 per cent from 1.8 per cent seen in the second quarter.
The ECB urged governments to use the current economic upswing to push through reform of the labour and product markets, in order to build confidence in a sustainable recovery and boost jobs and growth.
