European Central Bank president Jean-Claude Trichet has warned that uncertainty about growth in the euro zone economy is 'unusually high'.
He was addressing a press conference after the bank left its key interest rate unchanged at 4% in the face of high inflation. The comments were seen as increasing the chances of a cut in euro zone interest rates in the coming months.
The ECB President said that anchoring inflation expectations remained 'the highest priority' of the central bank, which has been under pressure from some European politicians to cut rates to spur growth.
He said the decision to hold rates today 'reflects our assessment that risks to price stability over the medium term are on the upside.' He warned that inflation in the euro zone was likely to remain 'significantly above 2% in the coming months and moderate only gradually in the further course of 2008.' The ECB has an inflation target of slightly less than 2%.
Mr Trichet also reiterated a warning about wage settlements in labour negotiations underway in many European countries. The ECB is concerned that pay increases in line with the current high level of inflation will spur price increase in the medium-term.
Both rate decisions had been expected by economists who doubted the ECB would be swayed despite sharp reductions by the US Federal Reserve, which slashed its key rate from 4.25% to 3% in just eight days last month.
As well as the problem of rising inflation, the ECB must also consider falling retail sales and consumer sentiment, as well as a sharp drop in the zone's key service sector which confirmed fears the bloc would not be spared from what looks like a serious US economic slump.
Economists said Trichet's comments marked a shift to a more 'neutral' stance, in contrast to previous threats of rates rises. 'It seems most unlikely that there will be a hike in interest rates at this stage,' said AIB Global Treasury, adding that it expected a rate cut by mid-year.
Ulster Bank's Simon Barry said the chances of a cut are rising, adding that even Trichet's language on inflation risks had softened slightly. IIB economist Austin Hughes said the ECB had called off a threat 'to act pre-emptively' against higher inflation, and Trichet's comments provided the bank with leeway for early rate cut if needed.
The ECB's 21-member governing council also maintained its two other key rates - the deposit rate and the marginal lending rate - unchanged at 3% and 5% respectively.
