FRANKFURT (MNI) – Recent comments from European Central Bank
Governing Council members show growing concerns over inflation risks in
the Eurozone, but fresh debt market tensions leave questions over how
soon such concerns will be translated into policy action.

Council member Axel Weber on Saturday warned that inflation risks
are already tilted to the upside. After Nout Wellink, he is the second
Council member to deviate publicly from the ECB’s official line that
risks to inflation are broadly balanced but “could move to the upside.”

“I believe that the turnaround in inflation developments may not
come as soon as we had expected in the past. Thus, [there are] already
very distinct risks that are more clearly tilted upwards,” Weber said.

Lorenzo Bini Smaghi also showed hawk feathers on Friday when he
told Bloomberg that “as the economy gradually recovers and global
inflationary pressures arise, the degree of accommodation of monetary
policy has to be monitored and, if needed, corrected.”

Commodity price increases will “have an unavoidable impact” and “it
is a key challenge for monetary policy to avoid spillovers and maintain
inflation expectations in check,” Bini Smaghi said. “This requires the
ability to take pre-emptive actions if needed.”

Weber’s comments may partially reflect a desire to cement his
legacy as a most committed price stability defender in the Eurozone on
his way out of the Council. Only a fortnight ago he still argued that
inflation “is attributable principally to special factors, such as
higher energy costs and should, even if it persists for a few more
months, remain of a temporary nature.”

Bini Smaghi’s comments, coming directly from the Eurotower, may
have to be taken more seriously.

Latest inflation indicators contained in flash PMIs only add to
concerns. Prices charged for goods and services rose at the fastest rate
since July 2008, while input price inflation was also at a 30-month
high.

Meanwhile, the ongoing economic recovery also reflected in PMI data
continues to make the monetary policy stance increasingly accommodative.
This is particularly true for the core countries. France’s and Germany’s
PMIs raced ahead again and Germany’s Ifo hit a fresh record high in
February.

Notwithstanding the force of Weber’s and Bini Smaghi’s rhetoric,
the case for policy tightening in the near term does not appear to be
closed:

Some doves are still around. Christian Noyer remains confident that
“at the end of the year, we should return within the zone of price
stability.” Vice-President Vitor Constancio argued that it would take
“further significant increases in commodity prices” or so far not
discernible second-round effects for inflation not to fall below target
towards the end of the year.

Perhaps more pertinently, the sovereign debt crisis — possibly
going into the next round — may yet hold the central bank back from
translating inflation concerns into higher interest rates in the near
term.

The ECB was forced to intervene in the markets on Friday for the
first time in a week to keep Portugal’s borrowing costs spiraling
further above the key 7% figure that is seen as making Portugal’s debt
unsustainable and may force it to seeking a bailout.

While a spokesperson for Portuguese Prime Minister Jose Socrates
told the Financial Times on Friday that any suggestion that the
government was negotiating a bailout was “totally false”, the rise in
Portuguese 10-year yields to 7.58% the same day increases the risk that
such talks may no longer be far off.

Policy makers certainly remain well aware of ongoing dangers from
the debt crisis. “The longer our political leadership delay agreeing on
a framework that will ensure stability, the greater is the threat that
we may have another crisis similar to what we experienced in 2010,”
Athanasios Orphanides said in an interview with the Wall Street Journal.

In this environment and with no expanded safety net in place yet,
the central bank will have to tread very carefully and may want to see
more evidence before further stoking the debt crisis by tightening
policy.

In radio interview on Sunday, ECB President Jean-Claude Trichet,
however, still seemed to allow for the possibility that current
inflation levels are a mere “hump”. As long as this is considered a
realistic option, the ECB may hope that sufficiently hawkish talk will
prevent second round effects from emerging and allow it to postpone a
first hike. “No second-round effects’ is our motto,” Trichet stressed
Saturday.

Still, inflation concerns are undoubtedly on the rise. Much may
depend on decisions about a larger and more flexible European Financial
Stability Facility to be reached by Eurozone leaders in March. A strong
deal in Brussels that provides a credible safety net for the Eurozone
periphery would free the ECB to focus on its inflation mandate and act
on rising inflation concerns.

A fortified EFSF could also allow a smoother ECB exit from extra
liquidity support by strengthening weak banks still reliant on it. As it
is, recent developments have highlighted that some banks remain cut off
from the wholesale market and reliant on central bank support. Overnight
lending is spiking far above the post-crisis average of around E100
million and reached as much as E16 billion on Friday.

The cause behind this spike is unclear. The Irish Times and Reuters
reported that Dublin-based banks stepped up emergency borrowing at the
ECB as the authorities are getting ready to sell assets and deposits of
the lenders. While most analysts do not think the spike is a reflection
of a return of broader markets tensions, there is little doubt that
parts of the banking system are still unable to operate without
assistance.

–Frankfurt newsroom +49 69 72 01 42; e-mail: frankfurt@marketnews.com

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