Trichet Faces Oil Shock That May Damp Growth, Fuel Inflation

European Central Bank President Jean-Claude Trichet may tell investors today how he plans to cope with an oil-price shock that’s driving inflation beyond the bank’s limit while also threatening to damp economic growth.

The ECB is the first of the world’s five biggest central banks to announce a policy decision since crude oil surged over $100 a barrel last week. While officials meeting in Frankfurt will leave the benchmark interest rate at a record low of 1 percent, Trichet may toughen his inflation-fighting language, leaving open the option of raising borrowing costs later this year, economists said.

“Trichet will have to assure the public that the ECB is alert and won’t tolerate inflation,” said Klaus Baader, co- chief euro-area economist at Societe Generale in London. “At the same time, the economic recovery is still rather fragile and spiking oil prices will weigh on consumption and company profits.”

Investors last week increased bets on the ECB raising rates as soon as August after policy makers including board member Juergen Stark said they will act if needed to prevent soaring commodity prices from driving up price expectations. Trichet must balance those inflation concerns against the risk of exacerbating Europe’s sovereign debt crisis by removing stimulus too soon. In addition to keeping rates low, the ECB is lending banks as much cash as they want and buying government bonds.

The ECB announces its rate decision at 1:45 p.m. and Trichet holds a press conference 45 minutes later. The euro was little changed today at $1.3869 as of 12:08 p.m. in Frankfurt.

Non-Standard Measures

Trichet may say whether the ECB intends to resume its exit from non-standard policy measures. It has so far pledged to keep offering banks unlimited amounts of cash in its weekly and three-month refinancing operations through the first quarter.

He will also unveil the central bank’s latest growth and inflation forecasts.

The ECB will probably raise its 2011 inflation estimate to more than 2 percent from 1.8 percent and may conclude that risks to the outlook have moved to the “upside,” Governing Council member Yves Mersch said in an interview published on Feb. 22. Inflation, which the bank aims to keep just below 2 percent, accelerated to 2.4 percent last month.

“We’ll see significant changes in inflation forecasts, especially for this year,” said Carsten Brzeski, senior economist at ING Group in Brussels. “But the projections will already be outdated because the latest oil-price spike came too late to be included.”

$100 a Barrel

Political tensions in Libya, the latest country to experience a wave of anti-government protests in North Africa and the Middle East, pushed crude prices above $100 a barrel on Feb 23. Libya, which ships most of its crude and fuels to Europe, has cut oil production by more than half, the International Energy Agency said on Feb 25. Oil traded as high as $101.47 a barrel yesterday.

Federal Reserve Chairman Ben S. Bernanke said on March 1 that the surge in oil and other commodity prices probably won’t cause a permanent increase in broader inflation and repeated that U.S. borrowing costs are likely to stay low.

By contrast, China on Feb. 8 raised rates for the third time since mid-October, and three of the Bank of England’s nine policy makers last month voted for an increase.

ECB Executive Board member Lorenzo Bini Smaghi said in an interview published on Feb. 18 that commodity-price increases will have an “unavoidable impact” on euro-region inflation and the central bank may need to take “pre-emptive actions.”

Second-Round Effects

The ECB is concerned about so-called second-round effects, when companies raise prices and workers demand more pay to compensate for soaring energy and food costs, entrenching faster inflation.

Henkel AG, a German maker of industrial and consumer chemical products, said on Feb. 24 it will raise prices in all businesses and all regions this year in response to rising raw material costs.

The ECB is “prepared to act decisively and immediately if needed” to prevent an “un-anchoring” of inflation expectations, Stark said on Feb. 21.

Investors expect the ECB to raise its key rate to 1.5 percent by the end of the year, with the first quarter-point increase fully priced in for September, Eonia forward contracts show.

The euro-area economy is showing signs of gaining strength. Manufacturing growth accelerated to the fastest pace in more than 10 years in February as companies ramped up production to meet export demand. In Germany, Europe’s largest economy, business confidence unexpectedly rose to a record high and unemployment dropped to 7.3 percent, the lowest in two decades.

‘Real Challenge’

Volkswagen AG, Europe’s biggest automaker, on Feb. 25 said profit surged sevenfold last year and forecast higher earnings in 2011 on Chinese sales.

Still, demand within the 17-nation euro area may be curbed as governments from Spain to Ireland cut spending to reduce deficits and shore up their financial systems.

The oil shock may further “handicap” the region’s recovery, ECB council member Guy Qiadensaid on Feb. 23.

Surging oil prices will be a “real challenge for the car industry,” Norbert Reithofer, chief executive officer at Bayerische Motoren Werke AG, said this week.

“The ECB would be sensible to leave itself some room to maneuver,” said Ken Wattret, chief euro-area economist at BNP Paribas SA in London. “If the oil price went up another $20 a barrel because of spreading unrest in the Middle East, then all bets are off. But if that scenario is avoided, the ECB is getting closer to thinking that its current policy stance is inappropriate.”

Bundesbank President Axel Weber will not attend today’s meeting and Vice President Franz-Christoph Zeitler will take his place instead, according to a spokesman for the German central bank. The decision is the first by the governing council since Weber announced on Feb. 11 that he won’t seek to replace Trichet and will step down from the Bundesbank at the end of April.

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