ECB Rate Increase Will Jeopardize Recovery, Ernst & Young Says

The European Central Bank will make a mistake and jeopardize the economic recovery if it raises interest rates this week to fight inflation, Ernst & Young said.

“An interest rate rise later this week, with subsequent rate rises later this year to try and dampen down the level of inflation, could potentially endanger the fragile economic recovery in the euro zone,” Ernst & Young’s Marie Diron and Mark Otty wrote in the company’s spring forecast for the region.

European inflation unexpectedly accelerated to the fastest in more than two years in March. ECB policy makers prepare to raise the main interest rate from 1 percent to fight increasing price pressures when they meet at the Frankfurt-based central bank on April 7.

“Raising rates as a response to commodity-driven headline inflation is a policy mistake,” Diron said. “Our forecast assumes that in 2012, as oil prices start to fall back, food prices return closer to fundamental levels and the effect of VAT increases from the beginning of 2011 disappear, inflation will again fall below 2 percent.”

The accountancy firm forecast the euro-region economy to grow 1.5 percent this year and 1.7 percent in 2012, driven by exports as the U.S. and emerging economies fuel global growth. Oil prices are forecast to drop to $95 by the end of the year.

A possible deepening of the Middle East crisis may raise oil prices, inflation and bond risk premiums, which could lead to renewed escalation of the European sovereign debt crisis, the economists said. An increase in oil prices to $150 per barrel would limit economic growth to 1.2 percent this year and 1.3 percent in 2012, according to the forecast.

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