Eurozone inflation jumps to 2.8%

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Eurozone inflation picked up more than expected to 2.8 per cent in April even as economic sentiment across the region took a clear turn for the worse and highlighted the possible risks of the European Central Bank’s interest rate raising strategy.

The jump in inflation, from 2.7 per cent in March, took the annual rate to its highest since October 2008 and could heighten the ECB’s fear that the effects of soaring energy and commodity prices will become entrenched through higher wage and other costs.

However, ECB optimism about the strength of overall eurozone growth may have been dented by a sharp drop in the European Commission’s “economic sentiment” indicator. The second consecutive monthly fall took the index to 106.2 in April, down from 107.3 in March, and the weakest since last November.

Eurozone unemployment, meanwhile, held steady at 9.9 per cent in March – with a rise in Spanish joblessness offsetting a fall in Germany. The fall in eurozone optimism and sluggish labour markets almost certainly reflected the impact of higher oil prices and inflation – and possibly of ECB interest rate increases.

Earlier this month the ECB started tightening monetary policy ahead of the US Federal Reserve and Bank of England, lifting its main interest rate by a quarter percentage point to 1.25 per cent. ECB policymakers have hinted at further rises with July appearing the most likely date, although June remains a possibility. The ECB holds its next interest rate setting meeting in Helsinki, Finland, next Thursday.

The latest surge in eurozone inflation could have been boosted by the late timing of Easter, which delayed price cutting sales by retailers and could instead soften May’s data. However, energy price trends have resulted in an inflation “hump” that looks set to prove larger and to last longer than the ECB had originally hoped. Although Eurostat, the European Union’s statistical office, gave no details, economists warned that “core” inflation, excluding volatile energy and food prices, had probably also accelerated in April.

The ECB hopes its “hawkish” stance will act as a powerful signal and prevent higher headline inflation having “second round effects” on wages. It aims to keep annual inflation “below but close” to 2 per cent over the medium term.

Jean-Claude Trichet, ECB president, struck a cautious tone earlier this week when he told Finnish journalists: “At the moment, I do not see any significant materialising of second-round effects and I do not see un-anchoring of inflation expectations.” He has been careful to avoid committing the ECB to a series of interest rate increases.

The ECB will also be wary about the strength of the euro, which is approaching the $1.50 level last hit in December 2009. The currency’s strength has added to the gloom about economic prospects in the countries worst hit by the eurozone debt crisis; Greece, Portugal and Ireland.

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