Businessweek Archives

Inflation: The European Union's Untamable Dragon


International Business: Europe

Inflation: The European Union's Untamable Dragon

Causes of the inflation scare are beyond the ECB's control

In Germany, motorists are cringing at every visit to the gas pump, as the cost of filling up a Mercedes S-class has climbed in the past year from $55 to $85. In Ireland, railway workers are on strike, demanding a 20% pay raise. Across the 11-nation euro zone, manufacturers are reeling in the face of a 10% increase in the cost of imported commodities over the past 12 months.

Inflation and all its attendant ills are again a hot political issue in Europe. And the inflation police at the European Central Bank are ready to ride to the rescue. But ECB President Wim Duisenberg and his partners will be faced with a serious problem when they meet Aug. 31: Nothing they do seems to have any impact. Despite four interest-rate hikes since February, inflation for the 11-nation euro zone is way beyond the monetary policymakers' 2% limit. The annualized figure was a worrying 2.4% in June and the same in July. And inflation numbers for high growth nations like Ireland and Spain are much higher.RAISING RATES. What should the ECB do? The betting is that either at this meeting or the next it will again raise interest rates, by a minimum of 25 basis points, to try to push inflation back down to somewhat acceptable levels. That will raise its key refinancing rate to 4.50%.

But the likelihood is that the move will again be ineffective. The causes of Europe's inflation scare seem beyond the ECB's control. Price rises have either been "imported" along with commodities like oil, or can be traced to the sickliness of the euro, which has added an estimated 0.6% to 0.8% to the euro zone's index of consumer prices this year. Currency markets have already taken a 25-basis-point rate increase into account--and the single currency is still bumbling along near its low of 88.44 cents.

As a result, the euro price of just about everything imported has soared. American soy products arriving in Europe are 11% more expensive, while City of London business consultants are charging euro zone corporate clients, on average, 13% more for their services.

Meanwhile, oil prices have surged by 50% since the beginning of 1999. That has sent the cost of gasoline skyrocketing--to more than $4 a gallon in France--and triggered a steep rise in manufacturing costs. BASF Corp., the German chemicals and pharmaceuticals giant, complains that rising energy and raw material prices will hit its profits in the second half of this year. Although sales are expected to increase strongly, earnings will grow little.

The dilemma of the ECB is that traditional economic tenets that say a series of rate rises should address the problem aren't working. To begin with, higher oil prices don't seem to be producing price inflation in goods and services. Competition in many sectors of the euro zone economy is so sharp that companies can't afford to raise prices. That's why economists expect corporate profitability--which rose a strong 20% in the first half--to stagnate for the rest of the year.

Unions are also by and large being conciliatory. The Irish railway workers' stiff demands are an anomaly. The bulk of the wage settlements concluded in euro zone countries this year have been modest--in the range of 3%.INFLATIONARY SPIRAL. Such moderation is good news, of course. But it deepens the conundrum of the ECB: It's far harder to justify interest rate increases when wage rises are under control, and there is little evidence that imported price rises are about to ignite an inflationary spiral. Yet for the sake of its own credibility, the ECB can't be seen to do nothing.

So the ECB is likely to do its duty and raise rates, even though the central bankers know in their hearts, like most clearheaded European analysts, that the best way to curb euro zone inflation is for national governments to deregulate markets and forge ahead with much-needed structural reforms. But that's a lot tougher than gathering some central bankers in a room to tighten monetary policy.By David Fairlamb in FrankfurtReturn to top


Steve Ballmer, Power Forward
LIMITED-TIME OFFER SUBSCRIBE NOW
 
blog comments powered by Disqus