ECB talks tough on euro zone inflation

COMBATING INFLATION could yet require higher euro zone interest rates, the governor of the Banque de France warned yesterday, sending the euro to a fresh high against the dollar.

The comments by Christian Noyer revealed a renewed determination by the European Central Bank (ECB) to talk tough on euro zone inflation, which hit 3.6 per cent last month - the highest in almost 16 years - as well as policymakers' faith in the robustness of economic growth, including in France.

An increase in ECB interest rates still seems unlikely, especially with the euro so high: yesterday it broke through $1.60 to the dollar for the first time. But financial markets no longer expect a cut in ECB interest rates this year.

The ECB believes the economic uncertainty created by global financial turmoil makes the direction of its next interest rate move unclear. Erik Nielsen, economist at Goldman Sachs, said the ECB's hardline stance was "a bit of a counterattack to the politicians", especially after the International Monetary Fund said there was room for cuts in borrowing costs.

"They wanted to get the pricing of a cut out of the market and they have achieved that now," he said.

While the US Federal Reserve and Bank of England have cut interest rates, euro zone official borrowing costs have remained at 4 per cent since last June.

"Our big problem is to ensure that inflation returns below 2 per cent next year," Mr Noyer told French radio. "If needed, we will move interest rates."

Other ECB governing council members have made similar comments in recent days and have also warned that ECB inflation forecasts might have to be revised upwards. But Mr Noyer's comments are significant because he is not usually seen as a "hawkish" policymaker.

France's economic outlook could play an important role in ECB thinking. The performances of the 15 euro zone countries are diverging significantly, with Spain facing a sharp housing market correction, while German economic growth is thought to be surprisingly strong.

"The fact that France is holding up in the middle is probably preventing euro zone [economic] numbers from moving significantly to the downside," said Jacques Cailloux at Royal Bank of Scotland.

France may be seen as a bellwether for the euro zone as its relative resilience lies in the absence of a credit crunch or slowdown in consumption. Mr Noyer said he expected the French economy to grow between 1.5 and 2 per cent in 2008. - (Financial Times service)