The European Central Bank (ECB) will likely raise interest rates by 0.25% to 4.25% this week, due to ECB President Jean-Claude Trichet's previous comments, plus rising inflation concerns. For one thing, the euro-zone money supply is soaring by double-digits. Specifically, May's M3 money supply rose at an annual pace of 10.5%. Trichet reiterated his concern over inflation when he stated that "upside risks to price stability over the medium term have intensified further over the past few months, within a context of very vigorous money and credit growth."
It is highly doubtful that the ECB can significantly slow the tide of inflation by raising interest rates alone, and raising rates could do damage to the fragile euro-zone economy. The risk of a recession in the 15-country euro-zone region has increased. Specifically, the Munich-based Ifo Institute's business climate index pointed to weaker German growth ahead. The Ifo dropped sharply from 103.5 in May to 101.3 in June, its the lowest level since December, 2005. The situation is even worse in France, where the country's purchasing managers' index recently fell to its lowest level in five years. There is no doubt that the future course of the euro-zone's two largest economies, namely France and Germany, will weigh on the ECB's decision this week.
High energy prices usually hurt Europe and other countries more than the U.S., due to high taxes on diesel and gasoline. Last week, a weak U.S. dollar, renewed inflation fears and Libya's threat to cut its crude oil production helped push crude oil to a peak of $142.13 per barrel. Additionally, a warning from OPEC's president that crude oil prices could hit $170 per barrel helped to propel crude oil prices higher. Chakib Khelil, OPEC's president, said he believes oil prices could rise to between $150 and $170 a barrel this summer, before declining later in the year. This adds to the global inflation threat, giving Trichet and the ECB another reason for raising rates this week.
Currently, inflation in the euro-zone is running at a 3.7% annual rate, the fastest pace in 16 years. Inflation is widely expected to top 4% soon. The U.S. Fed likes to focus on the "core" rate of inflation, excluding food and energy. But the U.S. dollar was on a slippery slope last week after the Fed left rates unchanged and investors around the world worried that the ECB would raise key interest rates this week, giving an interest-rate advantage to the euro.
The Fed's statement after its meeting this week implied that it was not that worried about U.S. economic growth being derailed by rising inflation. The next Fed meeting will be on August 5 and its is widely expected that, due to the upcoming election, the latest core PCE report, escalating financial problems and rising unemployment, the Fed will likely refrain from rising interest rates in August.
