FRANKFURT (MNI) – European Central Bank Governing Council members
said they are closely watching inflation developments but see no cause
for alarm yet after President Jean-Claude Trichet spooked markets with
unexpected hawkish tones on Thursday.

“Risks to the medium-term outlook for price developments are still
broadly balanced but could move to the upside,” Trichet said during the
introductory statement of his monthly press conference.

In comments that followed, only super-hawk Axel Weber stepped up
the rhetoric further, saying that inflation risks “could well” move to
the upside. Still, Weber also confirmed that price pressures “over the
policy-relevant medium term are expected to remain contained and in line
with price stability.”

Fellow hawk Juergen Stark did not sound alarmist. “We communicated
that we will closely monitor the situation and the question is whether
the upside risks that we spoke of today materialize. No one can tell
today; we have to wait and see over the next months,” Stark told
journalists Thursday night.

“A very decisive point is” that the stronger-than-expected climb of
the inflation rate mainly driven by energy prices, Stark noted.

Final HICP figures released Friday, showed that the annual
inflation level of 2.2% in December had indeed been boosted by price
increases for commodities. Core inflation, on the other hand, remained
stable at 1.1%.

Yves Mersch agreed that it is difficult to predict price
developments, but said he does not “believe that a noticeable increase
of our inflation projections is pending,” while Erkki Liikanen said that
“there is not yet a large concern” about inflation risks.

The fact that Council members stressed that inflation concerns are
still contained, coupled with Friday’s inflation report showing core
inflation of 1.1%, suggests that the new language on inflation is
primarily aimed at anchoring inflation expectations.

The ECB wants to make absolutely clear that it will not shy away
from raising interest rates even if the sovereign debt crisis continues
to unsettle markets. “We will always guard price stability and raise
interest rates if necessary,” Trichet told German public television
Thursday evening. However, he noted, “the figures for December can be
accounted for, above all, by rising energy prices.”

In additional interviews over the weekend — one in France and one
in Germany — Trichet largely repeated the same message. “We are always
concerned if inflation rises and are following developments very
closely,” the ECB President told German daily Bild in an interview
published Saturday.

However, speaking on French radio and television Sunday, Trichet
said, “”what always counts for us are not the rising prices of raw
materials or energy, which cause a hump in the level of inflation for a
certain period. What counts is to avoid what we call ‘second-round
effects’.”

But even if ECB concerns remain limited, upside inflation risks are
clearly back on the agenda and Governing Council members’ rhetoric will
be observed very closely by markets. Trichet’s comments on Thursday
helped push up the euro to a 1-month high against the dollar at the end
of last week.

The common currency also received some support from successful
government bond auctions by Italy and Spain on Thursday, by Portugal’s
sale of 10-year debt at lower-than-expected rates on Wednesday, and by
reports that Eurozone governments are working with the European
Commission to intensify their crisis-fighting efforts.

On Friday, French Finance Minister Christine Lagarde confirmed that
a “series of instruments” are being explored to be presented to EU
government leaders in March. “It’s still too early now” to give details,
she said. Lagarde did not say whether she supported a Belgian proposal
to double the size of the EFSF, but “it is not only a question of
money,” she said.

German Finance Minister Wolfgang Schaeuble, however, said Friday
that “we don’t need to speculate yet over whether or not to increase the
size of the rescue shield.” A day earlier he had noted that not even 10%
of the EFSF’s funds are committed yet.

Still, the Germans have confirmed that European leaders are working
on a comprehensive package and Schaeuble suggested that Europe might
prolong the repayment period for loans it has given to Greece. “The
timescale of credit for Greece is too short. We have promised that at
the start of 2011 we will discuss extending the timescale,” he said.

Although finance ministers said no announcements should be expected
before March, some details of the debate among European governments
could emerge early next week when finance ministers gather in Brussels
for the ECOFIN meetings.

Trichet’s tough tone on inflation, stressing that the central bank
will put price stability ahead of any crisis fighting efforts, might yet
push leaders to seriously step up their own efforts to contain the
crisis.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

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