News Analysis: Turmoil in Libya causes headache for EU economy

09:09, February 25, 2011      

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An escalating turmoil in Libya is causing a headache for the European Union (EU) economy by pushing up oil prices and stoking inflation fears in the 27-nation bloc.

U.S. crude oil price briefly crossed 100 U.S. dollars a barrel on Wednesday, hitting the triple digits for the first time since October 2008 amid concerns that chaos in Libya, the world's 15th biggest oil exporter, could disrupt supplies.

It was expected that world oil prices would remain at high levels for the time being, which abruptly increased inflation risk in the EU and may force central banks in Europe to raise interest rates sooner than later.

The European Commission forecast in November that inflation in the EU would be largely subdued in the following two years, leaving room for central banks to keep interest rate at record low levels to support economic recovery.

But the recent unrests spreading in North Africa and the Middle East altered the outlook, with soaring oil prices putting the EU on alert for an earlier arrival of high inflation.

Official figures from Eurostat, the EU's statistics office, showed annual inflation in the 17-nation euro zone had risen to 2. 4 percent by January, exceeding the target level of "close to but below 2 percent" preferred by the European Central Bank (ECB) to maintain price stability.

The rise of inflation happened even before the North African countries plunged into turmoil. Compared with one week ago, U.S. crude oil prices have increased by more than 15 percent, a serious challenge to the EU, which is heavily dependent on energy imports and liable to price volatility on world markets.

Confronted with mounting risk of inflation, European central banks are creeping towards rises in interest rates to contain price hike.

Several ECB policymakers have recently sounded alarm about the inflation development in the euro zone, a strong signal that the Frankfurt-based central bank of the whole euro zone may move ahead of its original schedule.

Luxembourg's central bank governor Yves Mersch, a member of the ECB's powerful governing council, said on Monday that the ECB may sharpen its language on inflation next week, indicating a readiness to raise interest rates in coming months.

Mersch's Dutch colleague Nout Wellink also warned of the distorting effects on financial markets and the economy if the ECB keeps its key interest rate at record low level for too long.

Following the financial and economic crisis, the ECB has kept its benchmark interest rate at one percent since May 2009, the lowest level since the euro zone was set up in 1999.

Analysts said the inflation fears generated by turmoil in Libya and wider Middle East may force the ECB to raise its interest rate as early as in the third quarter, but they warned any hasty decision to tighten monetary policy could stifle fledgling recovery in the euro zone when the region is still struggling with a sovereign debt crisis.

The sovereign debt crisis has created a "two-speed" Europe, which would pose additional challenge to the ECB's policy choice, analysts said.

For eurozone core members led by Germany, economic recovery is taking hold and there is good reason that they should guard against inflation risk, but peripheral countries like Greece and Ireland remain in trouble, and a tightened monetary policy may undermine their efforts to stimulate economic growth and consolidate public finances.

Britain, the EU's second largest economy which stays outside the euro zone, is facing the same kind of dilemma. Minutes from this month's meeting of the Bank of England's board showed a widening divergence among its nine policymakers on whether to raise interest rate, with an increasing support for a rise.

Inflation in Britain has climbed to more than twice its 2- percent target, even more serious than in the euro zone, but the British economy unexpectedly contracted 0.5 percent in the fourth quarter of 2010, obliging the Bank of England to have a second thought before any hawkish move on interest rate.

As rising oil prices fueled speculation that European central banks would raise interest rates sooner than forecast, the euro touched its highest in three weeks versus the U.S. dollar on Thursday.

A stronger euro would be a further blow to the EU economy since it may hurt exports when rising energy bill has already pushed up production costs, analysts said.

Source: Xinhua

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