German inflation suggests rate rise

The European Central Bank faces pressure to raise rates

German producer prices rose at their fastest rate for nine years, adding to pressure on the European Central Bank (ECB) to raise interest rates.

Producer prices rose by 0.7% in July, a year-on-year increase of 3.3%, the highest rate since 1991, when German unification had stimulated an economic boom.

The ECB is charged with maintaining price stability in the eurozone, which it has defined as keeping annual price rises below 2%.

July consumer inflation for the eleven countries who have embraced the single currency averaged 2.4%, leading the ECB chief economist Otmar Issing to say that the outlook for inflation had "worsened significantly".

The sharp rise in producer prices in Europe's largest economy suggests that inflationary pressures will be even stronger in the future.

"This is higher than expected and the probability is increasing that consumer price inflation in the euro zone will exceed 2% in 2001 as well as 2000," said Lothar Hessler of HSBC Trinkhaus.

The increase in the oil price was the main reason for the sharp upturn in producer prices, with oil product prices up 29.3% compared to one year ago.

Excluding oil, producer prices rose 0.6% for the month, 2.2% year-on-year.

Pressure on the euro

Adding to the inflationary pressures has been the weakness of the euro on foreign currency markets, which has pushed up the price of imported goods.

The euro dropped below $0.90 on Wednesday and came near to its all-time low of $0.8845 which it reached in May.

The hope that the ECB would raise interest rates, perhaps as much as 0.5% from the current level of 4.25% at its next meeting on 31 August helped the euro recover some of its losses.

A rate rise would boost the euro by making it more attractive to hold the currency.

But dealers were sceptical that the gains could be maintained.

"The market's still looking ahead, fearing slowing eurozone growth and rising inflation. The ECB promising to tighten will only make it worse," said Ken Landon of Deutsche Bank.

The market fears that Europe is facing a bout of stagflation, with both rising prices and weak growth, as the rate rises take their toll.

Those fears were boosted on Wednesday when a key index of German business confidence fell unexpectedly.

Michael Fuchs, the head of the German Association of Wholesalers and Exporters, warned that the German economy was not strong enough to withstand a rate increase.

However, the German government has insisted that its economy will grow next year by 3% to 3.5%, and ECB chief economist Otmar Issing has said that the eurozone's economic prospects are "better than they have been in the past 20 years".