Europe's economy is likely to grow more rapidly in the coming months but the upturn carries a risk of inflation that could lead to higher interest rates, according to the latest monthly bulletin from the European Central Bank (ECB).
Noting a substantial increase in the level of private sector borrowing and in the amount of money in circulation in the euro zone, the bank warns that "great vigilance" is required to keep inflation in check.
The ECB's president, Mr Wim Duisenberg, hinted strongly last week that the euro zone's period of low interest rates may be drawing to a close and there is a growing expectation that rates may rise in the coming weeks.
Although the Republic's inflation rate is the second-highest in the euro zone - 2.3 per cent compared to Portugal's 2.4 per cent - the cost of services in the State rose faster between July 1998 and July 1999 than in any other member-state. The Republic's increase of 3.8 per cent compares with a rise of just 0.9 per cent in the cost of services in Germany.
Observing that the difference between the highest and the lowest inflation rates within the euro zone is, at 2 per cent, much lower than in the 1980s, the report suggests that the rapid increase in the cost of services in such states as Ireland and Portugal may represent nothing more than a process of "catching up" with some of Europe's richer economies. Regardless of the cause, the bank warns that it will not tailor its policy on interest rates to suit the euro zone's divergent economies and insists that, if action is needed to cool down such economies, it must by taken by national governments.
"While the analysis of such cross-country differences is of interest in the context of assessing the evolution of the economy both on a cyclical and longer-term basis, it has to be stressed that the single monetary policy of the Eurosystem can only be geared towards the objective of price stability," the report says.
The ECB puts most of the blame for a recent rise in inflation throughout the euro zone on a rise in the price of oil, which ought to have no more than a temporary effect on price stability. The report warns that the rise in energy prices should not trigger excessive wage claims that could drive up inflation.
The report cites a wealth of data showing that industrial production in the euro zone has already started to pick up and is expected to improve more rapidly in the coming months. But the bank warns that many member-states still need to make structural reforms to their labour and product markets if they want to reduce unemployment and remain competitive.
"The anticipation of a cyclical improvement must not lead to a weakening of efforts in this regard, but should rather be used as a welcome opportunity to make convincing progress. This, together with continued wage moderation and fiscal adjustment in full compliance with the Stability and Growth Pact, would not only greatly facilitate the monetary policy task of maintaining price stability but would also substantially improve the prospects for economic growth and employment," it says.
