Forex News Update: Upside risks to price stability in the euro zone are increasing the European Central Bank said in its July monthly bulletin Thursday, after it raised its key interest rate a week ago.
The rate hike to 4.25% from 4% was necessary to fend off possible second-round effects of inflation, the ECB said, as high commodity and food prices could trigger follow-up markups in goods and services across the board.
High commodity prices are also becoming a drag on the economy, the ECB said, adding that its sees downside risks to gross domestic product growth.
The bulletin described current economic fundamentals as "sound" but gave a rather gloomy overall outlook for the euro zone's economy.
It said the ECB's rate-setting governing council of central bankers is concerned that currently elevated inflation levels could trigger the adjustment of firms' and households' future inflation expectations, which have the tendency of becoming a self-fulfilling prophecy.
Short term, inflation is expected to remain elevated at levels inconsistent with the ECB's definition of price stability.
The ECB defines price stability as an inflation rate of just below 2% over the medium term, but inflation has been well above this marker since September 2007. It was 3.7% in March and spiked to 4% in June, according to preliminary data.
Against this backdrop, the governing council said it would do what's needed to prevent such an unanchoring of inflation expectations and is "monitoring very closely" all developments, the bulletin said.
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