European Central Bank (ECB) president Jean-Claude Trichet stepped up his anti-inflation rhetoric yesterday after the ECB held euro-zone interest rates steady at 2 per cent in the face of rising oil prices.
But a downgrade to the ECB's growth forecast for this year and next caused bond prices to surge, after markets judged the ECB would be forced to think twice before raising rates.
The growth forecast was cut to around 1.8 per cent for 2006, compared with a 2.0 per cent forecast three months ago.
Inflation was revised upwards to about 2.2 per cent for 2005 and 1.9 per cent in 2006 from 2.0 per cent and 1.5 per cent respectively in the June forecasts.
Mr Trichet blamed the pressures from crude oil, which has shot up by over 25 per cent in the past three months. He said the ECB must be particularly watchful as rocketing oil prices could push up prices more broadly in the 12 countries that use the euro.
"At present, particular vigilance with regard to upside risks to price stability is warranted," Mr Trichet said. Rising oil prices place the ECB between a rock and a hard place, analysts said.
There is no simple solution to the twin problems of slowing growth and burgeoning inflation, beyond trying to convince markets everything is under control.
"The main message is that the talk is tough but action will be pragmatic," said Jonathan Hoffman, chief European economist for Royal Bank of Scotland Financial Markets.
