Euro rate hike seen as dove turns hawkish

The odds of an imminent hike in European interest rates shortened dramatically yesterday after one of the leading doves on the European Central Bank turned hawkish with a warning about mounting inflation.

The odds of an imminent hike in European interest rates shortened dramatically yesterday after one of the leading doves on the European Central Bank turned hawkish with a warning about mounting inflation.

Ernst Welteke, president of Germany's Bundesbank, said a weak euro and strong European growth were fuelling price pressures. Some countries were even showing signs of overheating, he said.

The single currency broke back through the $0.90 barrier after his speech in which he dismissed fears that further hikes in interest rates would harm growth. The euro rose as high as $0.9070, compared with a three-month low of $0.8905 on Wednesday. The latest bounce took some pressure off the single currency, analysts said.

Mr Welteke's remarks were interpreted as a hint the ECB will raise rates again when it meets next Thursday and also at its subsequent meeting on 14 September. Rates are currently at 4.25 per cent. The comments were also seen as significant as they came from a member of the ECB's interest rate board who is generally seen as doveish.

"This increases sharply the possibility of a rate hike as early as 31 August," said Lorenzo Codogno, senior economist at Bank of America. "Welteke has been doveish in the past and so this statement suggests that even among the doveish members there is sentiment for a rate hike." Mr Welteke said some eurozone countries were displaying signs of overheating. Ireland recently reported inflation at a 15-year high above 6 per cent. He also said the positive economic outlook for Germany had not been marred by the surprise fall in its business climate index earlier this week.

Mr Welteke said the ECB was "anything but pleased" about the euro's exchange rate, which hit a three-month low after the German figures.

The ECB, which is concerned that recent increases in headline inflation due to the weak euro and rising oil prices may provoke a wage-price spiral, has adopted an increasingly hawkish tone.

Mr Welteke said it was essential to counter price risks "as soon as possible" to ensure the eurozone's recovery could continue unhindered by inflationary expectations. The latest inflation figures showed prices rising at 2.4 per cent a year in July, the second consecutive month it has breached the ECB's target of 2.0 per cent.

"Now the issue is to pre-empt domestic second-round effects, which means domestic price and cost increases," Mr Welteke said, adding that so far there were few signs of wage-induced cost pressures.

The euro held on to its gains, ending at $0.9024 in London, despite an upward revision to US economic growth yesterday.