EU Raises Inflation Estimate, Increasing Pressure on ECB

The European Commission raised its inflation forecast for the euro region this year and projected the economy to gather strength next year, adding pressure on the European Central Bank to increase borrowing costs further.

Inflation in the euro region may average 2.6 percent this year instead of a previously projected 2.2 percent, the Brussels-based commission said in its European Economic Forecast published today. In 2012, annual consumer-price growth may slow to 1.8 percent. Gross domestic product will rise 1.6 percent this year and 1.8 percent next, it said.

The ECB last month raised its benchmark interest rate by 25 basis points to 1.25 percent, the first increase in almost three years, to fight oil-driven inflation. While governments from Greece to Portugal are struggling to contain a debt crisis and restore investor confidence, strengthening euro-region growth is giving policy makers room to focus on price pressures, with Belgium’s Luc Coene saying on May 11 that inflation risks have “shifted to the upside.”

“The risks to the inflation outlook are clearly tilted to the upside” and “further hikes in commodity prices can’t be ruled out,” European Commissioner for Economic and Monetary Affairs Olli Rehn told reporters in Brussels today. “The European economy is set to continue its recovery over the forecast horizon but developments remain uneven across member states” and “tensions continue in sovereign-debt markets.”

Economic Expansion

The euro extended gains after the data were released, trading at $1.4298 at 12:09 p.m. in Brussels, up 0.4 percent.

The euro-region economy expanded 0.8 percent in the first quarter from the previous three months, when it grew 0.3 percent, the EU’s statistics office in Luxembourg said in a report today. Economists had forecast GDP to gain 0.6 percent in that period, according to the median of 31 estimates in a Bloomberg News survey. GDP rose 2.5 percent from a year earlier.

In Germany and France, the region’s two largest economies, growth accelerated more than economists expected in the first quarter. Germany’s economy grew 1.5 percent from the fourth quarter, while France expanded 1 percent. That’s helping offset tougher austerity measures in periphery countries and softens the impact of rising borrowing costs.

‘Extremely Alert’

ECB President Jean-Claude Trichet signaled on May 5 that the bank may keep main lending rates on hold when policy makers meet next month by refraining from using the phrase “strong vigilance.” Still, the central bank is “extremely alert” on price developments, he said last week.

Crude oil prices have increased about 9 percent this year, breaching $100 a barrel in February. The commission forecast oil prices to average $117 a barrel this year and next, saying that the “still sizeable slack in the economy is expected to keep both wage growth and underlying inflation in check, partly offsetting expected increases in energy and commodity prices.”

The International Monetary Fund said yesterday that monetary “normalization lies ahead as economic slack gradually dissipates,” when calling the debt crisis the “most pressing challenge.” The economies of Greece and Portugal may shrink this year, while Spain and Ireland will return to growth, it said.

Greek bonds rallied this week on expectations that authorities will consent to another loan program to prevent a default. Greece’s first package worth 110 billion euros ($158 billion), 67.5 billion euros for Ireland and 78 billion euros that Portugal is set to obtain on May 16, will put the bill for quelling the debt crisis at 256 billion euros.

‘Unprecedented’ Effort

“While the fiscal effort of the past year is unprecedented, it’s clear that Greece has to seriously reinforce the implementation of its economic reforms” and “ensure full implementation,” Rehn said. The Greek economy’s rebound in the first quarter, with GDP rising 0.8 percent from the previous three months “is certainly good news.”

With governments cutting spending and raising taxes to plug shortfalls, companies have relied on export demand to bolster sales. Siemens AG (SIE), Europe’s largest engineering company, on May 4 forecast full-year profit to jump at least 75 percent, more than previously projected, after orders in India and China surged 58 percent and 15 percent respectively in the quarter ended March 31. Emerging-market orders rose 52 percent, the Munich-based company said.

‘Booming’ Sales

The Washington-based IMF forecasts the global economy to expand 4.4 percent this year and 4.5 percent next, with the euro-region economy growing 1.6 percent and 1.8 percent, respectively. China’s GDP may rise 9.6 percent in 2011 and 9.5 percent in 2012, the fund estimates.

Bulgari SpA (BUL), the Rome-based jeweller being acquired by LVMH Moet Hennessy Louis Vuitton SA (MC), returned to a profit in the first quarter and said it’s optimistic about its growth prospects. Watch revenue improved “significantly” in April and sales of fragrances are “booming,” Chief Executive Officer Francesco Trapani said on May 10.

“The eurozone economy had a buoyant start to the year,” said Nick Kounis, an economist at ABN Amro NV in Amsterdam. “However, there is early evidence that growth has since lost momentum, and given fiscal consolidation, higher oil prices and moderating world trade growth, we think that a slower pace of expansion is on the cards.”

European economic confidence weakened in April and German investor sentiment dropped more than economists estimated. French business confidence also weakened last month.

“The forecast for 2011 is clouded by geopolitical and economic uncertainties,” Hermes International (RMS) SCA, the French maker of Birkin handbags, said on May 11 after reporting a 26 percent increase in revenue for the first quarter. “As a result, it is difficult to make any projections.”

To contact the reporter on this story: Simone Meier in Zurich at smeier@bloomberg.net

To contact the editor responsible for this story Craig Stirling at cstirling1@bloomberg.net

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