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ECB to reveal if increased commodity prices or wages dictate rate increase policy

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On Thursday this week ECB is expected to be the first of the three leading central banks to raise interest rates by 25 basis-points in its main rate to 1.25 per cent.

The ECB announced at last month’s policy meeting its “strongly vigilant” stance against inflation. Eurostat published its flash estimates where Euro area annual inflation is expected to be 2.6% in March 2011. This is well over the 2% target.

Euro area hourly labour costs rose by 1.6% in the fourth quarter 2010 compared with fourth quarter 2009. It does not mean however that the Euro area workers got 1.6% more in their pockets. Breaking down the labour cost into its two main components it shows that wages and salaries increased 1.4% only and the non-wage part (employers social contributions and employment taxes) increased 1.9%.

What's the point of increasing the interest rate and what effect will it have on inflation? Inside factors are of course: Euro Area inflation and salaries. If inflation increases in the eurozone and salaries are subsequently increased to compensate for increased prices, then it makes sense to increase the rate to stem the spiraling effects. Outside factors: QE, prices of commodities, extra-ordinary events such as the Japan earthquake and the uprising in Middle East. Quantitative Easing continues, but not in the Euro Area! Printing money had its effect on the markets. What will happen when QE ends?

It is hardly for tackling new pressure by consumers to "over-spend" that is driving ECB to increase the interest rate. While Michel Barnier wants to give better protection to European consumers in the future (equals even more difficult to obtain a mortgage, further downward pressure of real estate, many are already heavily indebted and living on the minimum of margin. A rate increase will be most unwelcome by these mortgage holders.

The BP disaster in the Gulf of Mexico, the Middle East in revolt. Oil prices soaring. OPEC saw $750 billion of net oil export revenues in 2010 and one estimate suggests $847 billion in 2011.

Four days after the devastating earthquake and tsunami struck the Fukushima Daiichi plant in Japan, Germany - the engine of eurozone growth - declared a three-month moratorium on nuclear power, in which eight reactors will stay offline, checks will take place and nuclear policy may be reconsidered. In addition, a recently made decision to allow lifetime extension for nuclear power plants beyond a pre-established shutdown schedule has now been suspended, contingent of the results of safety tests. What effect will this have on energy prices and future industrial production?

Germany publishes two industrial surveys this week. Industrial orders on Wednesday are expected to have eased back in February to an annual increase of 15.9 per cent, still very much on the firm side. On Thursday, industrial production figures are expected to increase to an annual rate of 13.8 per cent, from 12.4 per cent in January. But if there is no cheap energy to produce the increasing amount of industrial products what effect will this have on Germany and the EU economy? In February 2011 compared with February 2010, industrial producer prices gained 6.6% in the euro area, which is much less than in Germany.

We look forward to read ECB's analysis of the economy on Thursday!

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