ECB faces combination of higher inflation, slower growth: Papademos says

European Central Bank Vice-President Lucas Papademos said the ECB is faced with an ‘uncomfortable’ combination of rising inflation and slower growth in the months ahead, adding that the euro’s appreciation is helping to curb inflation, suggesting the bank is in no rush to raise interest rates.

Speaking in Nicosia on Monday at a function organised by the University of Cyprus and the Cyprus Chamber of Commerce & Industry, Papdemos said “excessive volatility in exchange rates and abrupt movements are not conducive to economic growth.”

“The current conjuncture seems to point to an uncomfortable, though temporary, combination of higher inflation and somewhat slower economic growth in the coming months. Inflation risks and financial market volatility confront us with significant challenges,” he said.

But Papademos said the ECB remains prepared to act in an effective and timely manner to ensure that medium-term risks to price stability do not materialise. He said the uncertainty generated by credit market tensions require “continuous and very close monitoring of all developments”.

But he said the ECB does not yet have enough information to take any new decisions on interest rates.

“A thorough examination of additional information is warranted before further conclusions are drawn regarding the monetary policy stance,” he said.

Papademos said euro zone inflation is expected to remain at an ‘elevated level significantly above 2 percent‘ in the coming months but that it is then likely to moderate again in the course of 2008.

Inflation accelerated to 2.6 percent in October from 2.1 pct in September and 1.7 percent in August.

“The acceleration of inflation in the euro area is due to the unfavourable impact of developments in energy and agricultural prices, which could persist for some time,” said Papademos.

He said it is of the utmost importance that this rise in headline inflation does not affect medium to long-term inflation expectations and that inflationary wage rises are avoided.

But he said the ECB has been successful in containing inflation in recent years while keeping interest rates at low levels.

“Cyprus will enter a large economic area representing a zone of monetary stability with low inflation and low interest rates. Despite the large – almost unprecedented – number of substantial and prolonged adverse price shocks that have hit the euro area economy over the past few years, notably strong and persistent increases in oil prices, the ECB’s monetary policy has succeeded in keeping inflation under control,” he said.

Cyprus is due to adopt the euro in January.

Papademos said the euro zone economy is expected to grow at around its potential rate of just over 2 percent next year, but he acknowledged that this outlook is surrounded by heightened uncertainty and is subject to downside risks as a result of the recent turbulence in financial markets.

‘The ongoing process of risk reappraisal and repricing in financial markets could be more protracted than previously expected and may have a broader impact on financial markets and the economy,’ he said.

He also said the persistence of differences in the economic performance of some euro zone countries is worrying.

“If the persistence of higher than average inflation and stronger than average unit labour cost growth reflects structural rigidities in a countrys economy and the implementation of inappropriate policies, this is a matter of concern because of the likely adverse effects on competitiveness, long-term growth and employment creation,” he said.

ECB policy makers are divided on whether to raise interest rates. The euro has gained 9 percent against the dollar in the past three months, making euro-area exports less competitive and threatening to slow economic growth. Still, record oil prices pushed inflation to 2.6 percent in October, the fastest pace in two years.