Eurozone inflation reaches 16-year high

Eurozone inflation surged to the highest rate for 16 years on the back of sharply higher oil prices as consumer spending in the 15-country region showed further signs of weakness.

Annual inflation in the eurozone reached 3.6 per cent in May, according to official data released on Friday, up from 3.3 per cent in the previous month. That appeared to rule out any chance of an early cut in interest rates by the European Central Bank, which aims to keep inflation “below but close” to 2 per cent.

Evidence also emerged that higher prices were wreaking economic damage by forcing households to retrench. Germany reported a surprise 1.7 per cent drop in April retail sales, extending a 2.2 per cent fall in March.

This week, the European Commission reported eurozone consumer confidence had plunged in May to its lowest level for almost three years.

As well as driving inflation higher, the soaring cost of fuel has led to Europe-wide protests this week – with fishermen blocking ports in France and on Friday giving out fish free in Madrid.

The rising cost of fuel “eats into real purchasing power and transfers income from the eurozone to oil exporters, and that reduces income left for spending”, said Dirk Schumacher at Goldman Sachs.

German retail sales data are notoriously unreliable and could be revised substantially. But they seem to dash hopes that a revival in consumer spending in Europe’s largest economy will reduce its exposure to global economic storms.

To date, Germany’s economic recovery has been driven by exports and investment spending.

The ECB, which celebrates its 10th birthday on Monday, is likely to strike a hawkish tone after its meeting to set interest rates later next week.

It has kept its main rate unchanged at 4 per cent since last June – and economists expected it to remain on hold for some time.

Axel Weber, Germany’s Bundesbank president, said central bankers had popular support in their battle against inflation, arguing that the public had “had faith” in their “ability to deliver price stability” since the launch of the euro.

This week, Mr Weber had even raised the possibility of higher interest rates. But in a speech in Frankfurt he struck a more conciliatory tone.

While people were expecting higher inflation rates in the short term, expectations about the longer term “have increased only slightly and remain close to 2 per cent”, he argued. That showed the single eurozone monetary policy “remains credible”, he said.

By Ralph Atkins in Frankfurt
Published: May 30 2008

Source: Financial Times

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