Oct. 18 (Bloomberg) -- European Central Bank President Jean- Claude Trichet, using words rather than policy, helped bring the euro down from a record in his first year in office, shoring up an economic recovery reliant on exports.

Trichet, 61, is powerless over the biggest threat to growth as he enters his second year in the job: oil. The 68 percent surge in oil prices since January means ``uncertainties are augmenting'' for the economic outlook, Trichet said in an interview in Berlin.

Trichet has presided over the longest period of unchanged interest rates since the Frankfurt-based ECB took charge of monetary policy for the euro area in 1999, keeping the benchmark rate at a six-decade low of 2 percent. Maintaining that stance risks fuelling inflation, while a rate increase would reduce the chances of a rebound in consumer spending and investment.

``There's a dilemma shaping up next year between higher-than- expected inflation and lower-than-expected growth,'' said Joachim Fels, chief European economist at Morgan Stanley in London. Fels's team on Oct. 14 said oil prices may push the economy of the 12 nations sharing the euro into recession.

When Trichet took over from Wim Duisenberg in November, the economy was emerging from its first quarter-on-quarter contraction since the end of 2001. Spurred by the fastest global expansion in three decades, the ECB's staff predict growth of about 1.9 percent this year, up from a decade low of 0.4 percent in 2003. Inflation will miss the bank's limit of 2 percent for a fifth straight year, according to ECB forecasts.

Signs of Slowdown

Expectations of faster growth next year are fading. Expansion at manufacturers and service companies cooled and retail sales fell in September. Industrial production in Germany, France and Italy dropped in August. On Oct. 14, Detroit-based General Motors Corp. and Essen-based KarstadtQuelle AG, Germany's biggest department store owner, announced 17,500 job cuts in Europe.

In the Oct. 15 interview, Trichet backed away from the ECB's forecast that growth will accelerate to about 2.3 percent next year, saying expansion will ``continue'' at the 2.1 percent average annual rate of the past four quarters. At the same time, oil prices, which reached a record $55 in New York that day, require the ECB to remain on its guard about inflation, he said.

``This anchoring of inflation expectations is for us absolutely key,'' Trichet said. ``We have to be vigilant. It's important everyone sees that.''

Rejecting Rate Cuts

Demonstrating the inflation-fighting credentials he built up as Bank of France Governor, Trichet at the start of his tenure rejected calls from politicians including German Chancellor Gerhard Schroeder and French Prime Minister Jean-Pierre Raffarin to cut rates in order to revive growth and stem the euro's appreciation against the dollar.

Politicians and executives criticized his emphasis on inflation, pointing to U.S. Federal Reserve Chairman Alan Greenspan's more activist efforts to stoke growth in the U.S. Greenspan slashed rates as low as 1 percent in June 2003. The International Monetary Fund forecasts the U.S. economy will outpace the euro region's for the 13th year in 14 this year, expanding 4.3 percent against Europe's 2.2 percent.

``To this day, the European Central Bank hasn't taken decisions that would change the course of events,'' said Alois Michielsen, chief executive officer of Solvay SA, Belgium's largest chemical maker, in Brussels on Oct. 9. ``In contrast to the U.S. Federal Reserve, the ECB hasn't shown flexibility on interest rates, which, if they had been reduced, could have contributed to boosting consumption and economic activity.''

Shaping Maastricht

Trichet and the ECB counter that rate cuts don't stimulate the European economy in the way lower borrowing costs immediately persuade U.S. and British consumers to ramp up spending. At fault for the 9 percent unemployment rate are governments for not doing enough to attract investment, according to the ECB.

As head of the French treasury between 1987 and 1993, Trichet and former Bundesbank President Hans Tietmeyer, now 73, helped negotiate the Maastricht Treaty, which defined the ECB's primary goal as maintaining low inflation. In a sign of the two men's closeness forged in that period, a painting of Paris's Notre Dame cathedral by Tietmeyer's wife, Marie-Therese, hangs in Trichet's office on the 35th floor of the central bank's headquarters.

Still, there are signs that Trichet's views may be becoming more influenced by Greenspan, whom he refers to as ``my friend Alan,'' said Julian Callow, chief European economist at Barclays Capital in London. Trichet's change of tone on the effect of oil prices started after a meeting of finance ministers and central bankers of the Group of Seven nations in Washington on Oct. 1.

Down the Mine

``I can imagine that Greenspan is telling him at these meetings in Washington that he shouldn't be so rash as to raise rates until we have meaningful signs of a recovery in the job market,'' said Callow in an interview.

Like Greenspan, who wanted to be a baseball player, Trichet didn't start out as an economist. Born in Lyon, France in 1942, he wrote poetry as a teenager, studied engineering at the National Mining School of Nancy in eastern France and spent three months working down a mine.

``I was sometimes in very narrow veins of about one meter with a jackhammer,'' Trichet recalled in an interview with radio station RTL in August last year. ``At the age of 18 or 19, that's a very tough and exhilarating job at the same time.''

His biggest challenge in the first year as ECB president was tackling the euro's surge to a record against the dollar, a movement that threatened to choke export growth and pull the economy back into stagnation.

Currency Communication

A lover of French poets including Charles Baudelaire and a published poet himself, Trichet used words rather than interest- rate changes or currency sales to halt the euro's ascent. He said in Basel, Switzerland, on Jan. 12 that ``brutal'' exchange-rate moves were ``unwelcome.'' The currency stopped rising, dropping 3 percent in the following seven days. The euro was 2.8 percent below its Feb. 18 record of $1.2926 on Oct. 15, buying $1.2469.

His efforts to make sure the ECB's 18-member governing council ``speaks with one voice'' have been more successful than those of Duisenberg, said Richard Portes, president of the Centre for Economic Policy Research and a professor at the London Business School who first met Trichet in the 1980s.

Duisenberg, 69, earned a reputation for confusing investors in his first years as president, and in October 2000 inadvertently helped push the euro to a record low against the dollar after discussing currency strategy with the Times of London.

`One Big Mistake'

``Trichet has brought a certain coherence, discipline if you like, to the way the bank has communicated with the outside world,'' Portes said in an interview.

Only on one occasion did Trichet, who compares his job at the ECB with that of the captain of a rugby team, wrong-foot investors. He told the German Handelsblatt newspaper in an interview published March 24 that the ECB would revise its growth forecasts ``should our expectations for stronger private household consumption and domestic demand as a whole not be fulfilled.''

Investors took the comments as a signal that Trichet was preparing the ground for a rate cut as soon as the bank's next meeting on April 1, pushing the yield on the three-month Euribor March contract 10 basis points lower in the following three sessions. Instead, the ECB kept rates unchanged and Trichet told journalists after the rate decision that borrowing costs were low enough to keep prices under control.

``That was his one big mistake in terms of presentation,'' said Holger Schmieding, co-head of European economics at Bank of America in London. ``He seemed to promise a rate cut but didn't deliver on it.''

Dollar Depreciation?

In addition to the effects of record energy costs on the economy, Trichet may also have to grapple with a renewed appreciation of the euro, according to Andrew Bosomworth, a Munich- based fund manager for Pacific Investment Management Co., which oversees about $400 billion in assets.

The euro's rally against the dollar was partly caused by concerns about the U.S. current-account deficit, which rose to a record in the second quarter. Four U.S. Fed policy makers said in the past five weeks that a correction in the deficit would push the dollar lower, parting from a Fed convention of deferring to the Treasury on currency issues. Robert McTeer at the Federal Reserve Bank of Dallas said Oct. 7 the trade gap could still lead to a ``rapidly depreciating dollar.''

Bond investors have yet to decide whether Trichet will succeed in keeping inflation below 2 percent in the course of his eight- year tenure. Inflation expectations have risen since he was nominated to run the ECB in June 2003. French inflation-linked bonds indicate investors expect euro-region consumer prices to rise 2.19 percent annually over the next decade, compared with projections of 1.73 percent in mid-2003.

Clash With Chirac

``Investors are not sure if the tough words from him on price stability will really be followed by action and interest rate hikes if necessary,'' said Fels at Morgan Stanley. ``The market wants to be convinced.''

Investors questioning Trichet's determination to keep inflation under control should draw lessons from his time at the Bank of France, said Portes.

Trichet clashed with French President Jacques Chirac in the 1990s as he sought to convince politicians and executives that a strong franc, high interest rates and budget-deficit cuts would stamp out inflation and foster growth. In October 1995, two years after becoming governor of the Bank of France, Trichet raised rates to shore up the currency.

His policies worked, though they came at a price of unemployment of 12.3 percent. By 1999, inflation had slowed to 0.6 percent from 2.1 percent six years previously and the yield gap between French ten-year government bonds and their German counterparts, regarded as Europe's benchmark, narrowed to 7 basis points from 93.

France's Candidate

``When I was younger, France was not exactly a model of stability,'' said Alfons Verplaetse, who was governor of the Belgian central bank until 1999 and worked with Trichet in creating the euro. ``Trichet is a symbol of the new France, a symbol of monetary orthodoxy. He's not someone who will be very flexible when it comes to the Stability and Growth Pact.''

Trichet eventually won Chirac over. While Chirac said a month before becoming president in May 1995 that Trichet's call for spending restraint shouldn't be seen as ``gospel,'' he declared a year later that tackling the deficit was the only way to ``get France moving again.''

Chirac, 71, pushed Trichet as France's candidate to run the ECB when it started in 1998, losing out to Germany's candidate, Dutchman Duisenberg. Chirac, who went to the same civil servant school as Trichet, secured his appointment to the ECB post in June 2003 after Trichet was cleared of charges he helped Credit Lyonnais SA falsify its accounts a decade previously.

Deficit Dispute

His support from France's president hasn't erased the dispute between the ECB and finance ministers over deficit discipline. In November, ministers agreed to suspend the budget rules underpinning the euro to give France and Germany more time to cut their deficits, a move Trichet said carried ``serious dangers.''

Finance ministers say the ECB would make their jobs easier by focusing more on growth than on inflation. In April, French Finance Minister Nicolas Sarkozy and German counterpart Hans Eichel accused Trichet at a G-7 meeting in Washington of holding back the economy's potential by not cutting rates, according to a person familiar with the matter.

Trichet may face a tougher time convincing finance ministers of the need for reducing deficits in the euro nations than he did in France, according to Bank of America's Schmieding.

``There is no overarching political imperative now,'' said Bank of America's Schmieding. ``When it comes to fiscal policy, all he has is words and not acts.''

To contact the reporter on this story: John Fraher in Frankfurt jfraher@bloomberg.net.

Last Updated: October 17, 2004 19:11 EDT