FRANKFURT (MNI) – High inflation in Germany and the Eurozone might
prove more stubborn this year than initially assumed, Bundesbank Board
member Andreas Dombret cautioned Thursday.

Medium-term risks to price stability have increased and
second-round inflation effects cannot be ruled out, the central banker
said in a speech for delivery in Hamburg.

Germany will reach its pre-crisis level of economic activity at the
earliest by the end of this year and potential growth remains below
pre-crisis rates, Dombret said.

The price climate in Germany and the Eurozone has clearly worsened
due to global trends for energy, commodities and food, he pointed out.

“Higher inflation could definitely prove more persistent than
assumed up to now,” the banker warned. “Second-round effects also cannot
be ruled out.”

“In this respect, the medium-term upward risks for price stability
have increased,” he said. “At the same time the deteriorated price
climate with the connected loss of purchasing power has crystalized as a
risk for private consumption and for the economy.”

“For financial stability, it is indispensable that inflation
expectations remain anchored on a sustained basis.”

Turning to the German economy, Dombret estimated that potential
growth should recover to 1% by next year, up from 0.75% in 2009 and
2010.

Although it is possible for Germany’s deficit to fall in the
direction of 2% this year, now is not the time to stop the path of
consolidation, he argued.

Dombret argued that the sovereign debt crisis in the Eurozone at
present “presents without question the biggest risk to financial
stability.”

Monetary union must move in a clear direction, ensuring that public
finances are sustainable, he said. Structures for dealing with excessive
deficits and debts of individual member states “must be credible.”

“What is decisive is that countries’ own responsibility for their
fiscal condition remains clear without a doubt and that the incentives
to act early and on their own responsibility be strengthened, and not
weakened in the slightest,” he argued.

Speaking about a future European Stability Mechanism, Dombret
repeated that private creditors would have to be part of a solution for
a country that become insolvent — “indeed prior to the provisioning of
liquidity aid.”

Proposals that include shared liability and thus erode the
responsibility of states for their own finances are not appropriate for
strengthening trust in public finances, he underscored. “Therefore, the
introduction of Eurobonds would be seen very critically.”

–Frankfurt bureau, +49-69-720142, frankfurt@marketnews.com

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