ECB pressured to maintain interest rates

Inflation in Germany and the eurozone hit a three-year high in September, putting pressure on the European Central Bank (ECB) to maintain interest rates at its next monetary-policy meeting despite the escalating debt crisis and highlighting the difficulties in dictating monetary policy for 17 nations, especially when recession looms.

Driven by higher clothing and fuel prices, Germany's inflation rose to 2.8 percent from 2.5 percent in August, and overall eurozone inflation hit 3 percent from 2.5 percent in August, putting both rates well above the ECB's target of keeping inflation below or near 2 percent in the midterm.

"We think it's temporary, and there is some external pressure from high prices of raw materials, but also in some countries like Germany, there is some domestic demand caused by higher employment levels," said Pavel Mertlík, chief economist at Raiffeisenbank.

Despite the slowdown in growth across the eurozone and in Germany, unemployment actually fell to its lowest levels in Germany since reunification to 6.9 percent, dropping by 26,000 in September as companies continued to hire despite low growth fears.

"The labor market is the most lagging indicator," Mertlík warned. "Companies, when there is the risk of a slow down, don't typically hurry to fire people. They start with the less unpleasant cost-cutting actions."

He said the drop is "the outcome of past developments" like structural reforms to make the labor market more flexible several years ago, and also subsidized employment.

"But in the end, if you look at such figures like factory orders, they are quite sharply decreasing in Germany and the rest of Europe," he said.

That decrease will be a hit for the Czech Republic, which depends largely on Germany to buy its exports.

"For the time being, foreign company orders are very strong, unlike local ones that have been negative in the last three months. But there will be deterioration here, it's only a question of time," Mertlík said.

The numbers will likely delay any ECB move to cut the interest rate, which is expected in the coming months as the eurozone heads towards possible recession with grim economic and manufacturing growth numbers and as the sovereign debt crisis becomes more and more urgent with the threat of Greek default. In the meantime, the ECB is working to pump liquidity into banks.

Cat Contiguglia can be reached at
ccontiguglia@praguepost.com