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Blow to rate cut hopes after central banks sound warning over threat from inflation

January 08, 2008 | Times Newspaper

The world’s leading central banks yesterday emphasised their vigilance against inflation in the face of soaring food and energy costs, dampening market hopes of aggressive interest rate cuts in response to financial upheavals.

In a hawkish summary of talks among the Group of 10 central banks from leading economies, Jean-Claude Trichet, President of the European Central Bank, talked up world growth prospects and sounded a warning against complacency over inflation.

Mr Trichet, the G10’s chairman, also told big financial institutions that they must shoulder responsibility for tackling money market stresses and the global credit squeeze, and not expect all the onus to fall solely on central banks and governments.

The ECB chief’s comments came as Gordon Brown yesterday reiterated his warning over the “dangerous” year ahead for Britain’s economy and predicted “what is clearly several months of global financial turbulence”.

While acknowledging that risks to world growth were “clearly on the downside”, he said the G10’s view was that: “We see growth continuing at a pace which is quite robust — even if there is a little bit of slowing down.”

The scale of any toll on the global economy from money market strains and the credit squeeze was “something that still has to be fully understood”. Mr Trichet added: “The possible consequences for the real economy are still open.”

He left little doubt, however, of the central banks’ persistent concerns over inflationary threats. “The spike in oil prices, the spike of commodity prices, the spike of food prices, are having an effect on headline inflation. The risk of a spiralling of this headline inflation in the medium run was considered by a large number of colleagues as an important risk, calling of course for no complacency.”

Mr Trichet said that the G10 saw a widespread threat that higher energy and food costs could stoke wage demands and lead companies to push up prices, risking an inflationary spiral.

“We have identified . . . in large parts of the global economy the danger of second-round effects,” he noted.

With unprecedented joint action by the central banks to pump extra funds into world money markets to prevent them from seizing up appearing to have been largely successful, the ECB President said that the G10 was “very satisfied with the actions that we embarked upon”.

He left open the question of whether further concerted G10 action to quell market tensions might follow, saying only: “We remain in very close, confident contact in the future, as we have in the past.”

Commercial bankers who attended the weekend’s G10 gathering in Basle for consultations were reported to have welcomed the central banks’ December moves. David Dodge, Governor of Canada’s central bank, said: “The clear message was that what we did in terms of concerted action over the year-end was helpful.”

But in a warning shot to Wall Street and European institutions, Mr Trichet insisted that the private sector must play its own full part in restoring calm, amid persistent stresses in markets, including those for asset-backed securities and commercial paper. “It calls for progressive, appropriate actions by the private sector in particular,” he said.

“We will remain alert, taking into account what we can do, and what we can help, which is permitting the functioning of the market to improve progressively.”

Henry Paulson, the US Treasury Secretary, also emphasised last night that there were no instant solutions to the problems of America’s housing slump and the sub-prime crisis, although the US Government would attempt to mitigate the fallout by preventing “avoidable foreclosures”.

“There is no single or simple solution that will undo the excesses of the last few years,” he said in a speech in New York.

Mr Paulson gave warning that the United States was facing an unprecedented wave of 1.8 million sub-prime mortgages issued to poor Americans with low credit ratings which would reset to higher interest rates over the next two years.

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