Eurozone annual inflation hit the European Central Bank's price stability target for the ninth month in a row in May but economists expect it to pick up later in 2007 with the ECB raising interest rates further.
European Union statistics office Eurostat said prices in the 13 countries using the euro rose 0.2 percent month-on-month for a 1.9 percent year-on-year gain as cheaper fuel and phone calls offset dearer restaurants, cafes and cigarettes. The annual figure was in line with Eurostat's early estimate and market expectations.
The ECB aims to keep inflation just below 2 percent and has been raising interest rates since December 2005 to keep it in check amid robust economic growth and a tighter labour market.
While inflation has remained below but close to 2 percent since September 2006, economists said it was bound to pick up towards the end of the year, prompting more ECB rate rises. "Headline inflation, after a trough in July at 1.7 percent, is likely to reaccelerate to around 2.3 percent by December, before returning to around 2 percent in 2008," said Luigi Speranza, economist at BNP Paribas. UniCredit economist Marco Valli said he expected headline inflation above 2 percent in September and peak at 2.4 percent in the first quarter of 2008.
But ECB Governing Council member Miguel Fernandez Ordonez said in Madrid that despite upside risks to inflation, he expected eurozone price growth to remain around 2 percent in 2007 and 2008 and in line with the ECB's price stability target. Another Governing Council member Guy Quaden stressed the ECB's policy decisions in the second half of the year would be "more than ever" dependent on data.
"The Governing Council has not said that the tightening cycle has ended. Neither has the Governing Council said that a new hike would in any case be necessary. Month after month we will assess incoming data," he told a news conference.
Inflation excluding volatile unprocessed food and energy costs, which the ECB calls core inflation, also was 0.2 percent month-on-month and 1.9 percent year-on-year, with the annual rate again unchanged since February. The bank watches core inflation closely to determine the pass-through of higher oil prices into prices in other sectors.
The bank raised rates to 4.0 percent last week. Markets expect it to do so again in September and possibly once more after that, taking borrowing costs to 4.5 percent to stem inflationary pressures from fast credit growth and possibly higher-than-expected wage rises.
"We can't rule out that the strength of economic activity translates into higher salary demands and higher prices from companies," Ordonez said. But Eurostat data showed hourly labour costs in the eurozone rose 2.2 percent year-on-year in the first quarter of 2007, the same as in the previous three months, with wage growth slowing to 2.3 percent from 2.4 in the previous quarter.
Euro zone unemployment has been falling steadily since the middle of 2004 to reach a record low of 7.1 percent in April. "This indicates that tightening labour markets have, so far at least, not pushed up pay markedly across the eurozone," said Howard Archer, economist at Global Insight.
The modest wage growth in the whole of the eurozone was mainly thanks to wage restraint in the biggest economy, Germany, where they inched up only 0.1 percent in the first three months of the year. But because wage talks are still under way in some sectors, the ECB is keen to moderate their growth for the average not to rise quickly, economists said. In France, for instance, wages grew 3.8 percent year-on-year after a 3.4 percent increase in the previous quarter.