ECB urges eurozone members to cut back on spending

The European Central Bank yesterday warned that the value of the euro would be further undermined unless member governments cut their public spending plans.

The European Central Bank yesterday warned that the value of the euro would be further undermined unless member governments cut their public spending plans.

The bank said it was worried that countries were planning to cut taxes at a time when the European economy was starting to accelerate.

The ECB said it welcomed tax reforms but said they were only being partially offset by cuts in spending. "They need to be compensated by spending cuts to prevent a pro-cyclical loosening of fiscal policy and by preserving the process of fiscal consolidation," it said in its monthly bulletin.

It urged governments to carry out structural reforms to improve economic productivity and efficiency.

"The prospects for a stronger potential for growth in the euro area and for the external value of the euro will depend very much on whether progress is made along these lines," it said.

The euro mounted a recovery yesterday after plunging to new lifetime lows in eight out of the last 11 trading days. It gained more than a cent against the dollar to approach $0.86 compared with Wednesday's low of $0.8440.

The ECB is still smarting from criticism by the International Monetary Fund over its failure to intervene to prop up the euro. "The decline in the exchange rate of the euro contrasts more and more with economic fundamentals," the bank said.

The ECB also warned it was likely to hike interest rates again, citing inflationary threats from the weak currency, the oil price and excessive wage demands.

"The Governing Council will continue to remain alert to emerging risks to price stability," it said, highlighting the falls in the euro a "cause for concern".

"The main upward pressures on euro area inflation currently come from increases in the price of oil," it said.

The ECB said monetary policy could not offset short-term movements in inflation caused by external factors such as oil. "But monetary policy must contain the risk of the prolonged period of upward pressure on overall inflation spilling over into costs and prices in the domestic economy."

The ECB said this included keeping wage inflation under control. "Any attempt to raise wages ... would be highly detrimental as monetary policy would need to react to the resulting upward pressure on prices."

Yesterday investment bank Salomon Smith Barney revised up its inflation forecasts for the eurozone, saying it would remain "uncomfortably close" to the ECB's 2 per cent target until the end of next year. Inflation currently runs at 2.4 per cent.

Jose Luis Alzola, a European economist, said it expected interest rates to rise from 4.25 per cent now to 5.75 per cent next year. "The ECB may act more aggressively near-term if the euro fails to stabilise and start a gradual recovery soon."