Speculation that the European Central Bank (ECB) would buy euros to lend support to the single currency, after a 10 per cent drop in its value so far this year, saw it bounce off its lows yesterday. Calls for a stronger euro from two central bank officials reinforced speculation the ECB would intervene, as reports showed inflation accelerated in May in several euro-zone countries.
But rising inflation, deteriorating growth prospects and spiralling budget deficits across the euro zone are presenting the ECB with a difficult dilemma, with analysts divided over whether rate cuts or intervention - or neither - are likely.
Evidence has been mounting in recent months that the global economic slowdown is hitting the euro area harder than expected. As a result many believe the ECB should cut rates to stimulate growth.
But the ECB has repeatedly pointed to inflation as the reason why it cannot cut rates. Confirmation yesterday that inflation is continuing to soar in France and Germany may put a dampener on prospects that the ECB will lower interest rates, while a sinking currency adds to the pressure by increasing import prices.
Some analysts believe rising prices put pressure on the ECB to deal with the currency and intervene. However, others say it will carry on with rate cuts in an attempt to boost growth.
The euro climbed to $0.8490 from $0.8421 a day earlier when the currency had hit a six-month low. This is below the level at which the central bank has previously stepped in to defend its value. The ECB last bought euros on three days in early November 2000, between $0.85 and $0.87. The first round of intervention in September was around the same level.
Bundesbank president Mr Ernst Welteke warned that "the development of the euro exchange rate must be monitored very closely with a view to possible dangers to price stability . . I would like to again stress our great interest in a strong euro", Mr Welteke said.
Bank of France governor Mr Jean-Claude Trichet also indicated the weaker euro fuelled inflation in France. "The euro exchange rate is an important indicator for the single monetary policy," Mr Trichet said.
Rising energy costs account for faster inflation. The cost of oil rose by a fifth between early April and the end of last month, reaching a six-month high of $29.42 per barrel on May 21st.
However, according to Mr Jim Power, head of investment at Friends First, the ECB may cut interest rates in the coming weeks. Writing in the firm's first weekly market commentary, Mr Power said that further interest rate cuts are likely.
He added that a cut at the ECB meeting in Dublin next week is a real possibility. "Further delays by the ECB will serve to elicit even more negative reaction from the financial markets."
