Europe's Central Bank Warns on Prices

FRANKFURT—ECB President Jean-Claude Trichet scrambled to counter an unexpected rise in euro-zone inflation, signaling that he won't hesitate to raise rates if recent signs of price pressures become firmly entrenched.

In his monthly press conference, Mr. Trichet also appealed to European leaders to move quickly to increase the size and flexibility of a rescue fund aimed at stemming contagion from the currency bloc's widening debt crisis, saying "there is a sense of urgency."

But it was his inflation warning that created the biggest stir in financial markets. Money-market rates rose during Mr. Trichet's press conference, and the euro jumped above $1.33 against the U.S. dollar as investors reassessed their European interest-rate forecasts.

The European Central Bank kept its main policy rate at a record-low 1%, where it has been since the height of the global recession in May 2009. But Mr. Trichet's remarks put a rate increase later this year squarely on the table. The central bank chief appears increasingly uncomfortable with the ECB's very accommodative policy stance 18 months after the recession ended. December inflation data in the euro zone, released earlier this month, accelerated to 2.2%, putting it higher than the ECB's target of below 2% for the first time in more than two years.

"We are never pre-committed" on interest rates, Mr. Trichet said. "We have proved that in the past...it is important to keep that in mind." Mr. Trichet said that while he still expects inflation to drift back below 2% toward the end of 2011, risks "could move to the upside."

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Reuters

'We are permanently alert. We are never pre-committed not to move interest rates. Our level of interest rates is designed to deliver price stability,' Jean-Claude Trichet said.

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Transcript: Trichet's Introductory Remarks

"The pain threshold is being crossed," says Royal Bank of Scotland economist Nick Matthews. "The ECB is probably looking at an inflation forecast that's above 2%" for 2011.

On three separate occasions during his hourlong press conference, Mr. Trichet cited the ECB's last rate increase, which was in July 2008, just weeks before the Lehman Brothers failure sparked a global financial crisis. Though that decision has been criticized by some, Mr. Trichet sees it as proof of his anti-inflation credibility even in the face of market turbulence.

Mr. Trichet also emphasized that the ECB could raise interest rates while maintaining its crisis-lending programs, which provide unlimited loans to commercial banks at maturities up to three months. ECB watchers have long assumed that the central bank would unwind those programs before raising interest rates. "These two concepts are disconnected," Mr. Trichet said.

"It's a bolt from the blue," says Ken Wattret, economist at BNP Paribas in London. "Most people have been associating [monetary policy] with the sovereign-debt crisis, and suddenly the ECB has put a rise in inflation on the agenda," he says. Mr. Wattret is sticking to his forecast that the ECB won't raise interest rates until next year, but sees a clear risk that rate increases might come sooner.

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For now, many economists see Mr. Trichet's tough talk as largely a verbal effort to keep expectations for future inflation firmly in check. Fragile economies in Greece, Ireland, Portugal and Spain will keep the ECB from raising interest rates for at least the next few months, many analysts say. The ECB on Thursday kept its crisis-era lending programs in place—a lifeline to banks in Ireland, Greece and Portugal that have difficulty accessing funds in private markets—and Mr. Trichet said the ECB's government-bond purchase program is continuing.

The ECB has so far bought €74 billion in Irish, Greek and Portuguese government bonds since the program started in May. Though ECB officials appear reluctant to make large-scale purchases, they have intervened in a targeted way, as they did Monday and Tuesday ahead of Portugal's key bond sale, according to bond traders.

Mr. Trichet declined to comment on whether the ECB bought bonds this week, and rejected speculation that it was trying to smooth Lisbon's debt sale. The ECB's aim is to make its interest-rate policies transmit smoothly through financial markets, Mr. Trichet said, adding there is "no other goal than that."

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