ECB raises its forecast for euro-zone inflation in 2004

The European Central Bank raised its forecast of euro-zone inflation for 2004 yesterday, but signalled monetary policy was on hold and analysts said market expectations of swift interest rate hikes were overdone.

The central bank's outlook for an economic recovery to take hold next year remained unchanged, and the ECB repeated that its interest rate level was appropriate, given that inflation would drop below its 2 per cent tolerance ceiling next year.

Inflation was now seen between 1.3 per cent and 2.3 per cent on average next year, which gives a mid-point of 1.8 per cent. That is up from a range of 0.7 - 1.9 per cent forecast in June, or a mid-point of 1.3 per cent. Inflation would then drop to within a band of 1.0 - 2.2 per cent, implying a 1.6 per cent mid-point, in 2005.

The ECB had already said that its June forecast for inflation was probably too low because of high oil and food prices and government tax increases.

Mr Bernard Walschots, Rabobank head of financial market research, said the ECB's inflation forecasts showed there was no need for it to tighten monetary conditions soon.

"We will only be back at (2 to 2.5 per cent) trend potential (GDP) growth in 2005 and from that perspective too, I see no reason why the ECB should hamper a recovery by hiking interest rates," Mr Walschots said.

Money markets have scaled back their expectations of aggressive ECB interest rate hikes, but are still pricing in roughly a 40 per cent chance of a 25 basis points rate hike in March and fully discount such a rate hike by June. But most economists expect the ECB to hold fire at least until the second half of next year.

The updated projections for the harmonised index of consumer prices (HICP) made by ECB staff were published in the bank's December monthly bulletin.

The strong euro - which the ECB assumes to be at $1.17 to the end of the forecasting period - provided an extra reason why euro-zone interest rates would remain at their present low levels for quite some time, Mr Walschots said.

The 2004 growth outlook remained unchanged in a 1.1 percent to 2.1 per cent range, for a mid-point of 1.6 per cent, while growth in 2005 would further accelerate to a 1.9 per cent-2.9 per cent range, giving a mid-point of 2.4 percent.