Papademos sees inflation risks

ST LOUIS, MO – European Central Bank Vice President Lucas Papademos said on Thursday that globalization had helped contain prices so far, but that the risks to inflation were now rising due to buoyant world growth. «While acknowledging that globalization has helped to contain inflation… we cannot rely on it to keep inflation under control independently of global cyclical positions and monetary conditions,» Papademos said during a panel discussion at a conference hosted by Washington University in St Louis and the Federal Reserve Bank of St Louis on «The Euro and the Dollar in a Globalized Economy.» A global «output gap» may help explain why the pass-through had been restrained even after two years of soaring energy prices, but this protective shield was now slipping, he warned. «Inflationary pressures may be increasing in the coming quarters as the global economy continues to expand at a robust pace, greater than the estimated range of rates of global potential growth,» he said. Papademos said traditional measures used by central banks to assess policy were muddied by the globalized economy and its mass of low-cost skilled labor – and related downward pressure on wages in industrial countries – on the one hand and additional demand on resources on the other. «The integration of rapidly growing, large emerging market economies has put upward pressure on energy and commodity prices. This impact is more visible and relatively easier to quantify,» Papademos said. However, «traditional measures of core inflation are more difficult to interpret and use as indicators of underlying domestic inflationary pressures… the measurement and usefulness of output gaps are subject to greater uncertainty,» the central banker added. The ECB, which sets interest rates in the 12-nation common currency zone that uses the euro, has proclaimed its «vigilance» on inflation, citing rising energy prices and commodities prices, the stimulative impact created by years of low interest rates and other structural factors. It has issued a string of warnings that has primed financial markets for an interest rate rise at its next policy meeting, in Madrid on June 8. That would be the third hike since December 2005, when the ECB ended more than two years of record low eurozone interest rates that had left its key lending rate at 2 percent. A poll of analysts published by Reuters on May 22 found a median forecast of an ECB rate hike to 2.75 percent next month from 2.5 percent at the moment, with a further rate increase to 3.0 percent likely by year-end. «Maintaining price stability in a rapidly evolving globalized economy that may influence the dynamics of inflation in various ways becomes more essential and challenging. The anchoring of inflation expectations to price stability in a country or economic area is also vital in a globalized economy,» Papademos said. Papademos also warned currency movements could play only a limited role in resolving global imbalances, reflecting concerns that the rising value of the euro against the dollar could sap Europe’s economic recovery. He took issue with the theory that foreign exchange rates and inflation differentials should play a greater role in easing the record US current account deficit and surpluses in China and other Asian economies. «The scope for orderly adjustment through the exchange rate channel is limited,» Papademos said. The response of current account balances to exchange rate changes has been subdued in recent years, possibly because of structural changes, he said, adding that while imbalances are not sustainable in the long term, «foreigners have evidently not lost their appetite for US dollar assets.»