European Central Bank's Draghi Says
Oil Prices `Limit' Monetary Policy

FLAVIA KRAUSE-JACKSON & FLAVIA ROTONDI
Bloomberg 31may2008

European Central Bank council member Mario Draghi said record oil prices are dictating the level of borrowing costs.

"The main element of concern remains the continued rise in the price of energy and other commodities," Draghi said today at the Bank of Italy's annual assembly. This is "fueling inflation and limiting the direction of monetary policy. Medium- term price stability was and remains the objective."

The ECB defines price stability as keeping inflation just below 2 percent "over the medium term" and has struggled to meet that goal since taking charge of monetary policy in 1999. The central bank left its key rate at 4 percent on May 10 to try to curb the surge in energy and food prices. Still, the inflation rate in the 15-nation euro economy rose to 3.6 percent, the ninth month it held above the ECB's target.

There are few signs of inflationary pressures abating. Crude oil prices have gained 33 percent this year, reaching a record $135.09 a barrel on May 22. Food commodities have also surged in the last year, boosting how much consumers are paying for staples such as bread and milk. Wheat, corn, rice and soybeans have risen to records this year as stockpiles shrink and demand climbs.

Inflation in the euro region is "worrying" and will stay at current levels for some months before slowing, if the oil price doesn't rise further, said Lorenzo Bini Smaghi, an ECB executive board member, in a speech today in Trento, northern Italy.

"Based on the data that we have and based on oil-price data, which is very difficult to forecast, we predict inflation will stay at these levels for some months and then come down," Bini Smaghi said.

Inflation Challenge

The global rise of oil and commodity prices makes inflation more difficult to manage for central bankers, Nout Wellink, an ECB council member, told Dutch newspaper De Telegraaf.

"Inflation is not `home made,' like it used to be, so it's harder to tackle by a central bank," Wellink told the newspaper.

Faster inflation is already eroding confidence among households. European consumer confidence unexpectedly dropped to the lowest in almost three years in May, the European Commission in Brussels said yesterday. In Germany, Europe's largest economy, consumers also grew more pessimistic, according to a survey released this week by GfK AG.

Italy is the worst-performing economy in Europe and barely dodged a fourth recession in a decade. Newly elected Prime Minister Silvio Berlusconi's first act after taking office May 8 was to pass tax cuts on property and overtime pay and offer to freeze mortgage payments for homeowners at risk of default.

Frozen Mortgages

The government agreed this month with ABI, the association of Italian banks, on a plan that gives first-time property owners the chance to freeze mortgage payments at 2006 levels, when the ECB's benchmark rate was 2 percent. The new measures, which take effect Jan. 1, 2009, could affect 1.25 million families that face higher interest payments on variable-rate mortgages.

"Rates in the past were too low," Draghi said.

Italy's growth prospects are being further dimmed by the euro's gain against the dollar, which makes its exports more expensive in the U.S., its third-biggest market. The single currency has gained 6 percent in the past six months and trades for about $1.57. Italian exports plunged 1.3 percent in the fourth quarter. The U.S. is the country's No. 3 trading partner.

"The weakness will drag on for at least the current year," Draghi said.

source: 1jun2008