Inflation in the dozen euro nations accelerated to its highest rate in more than two years in May amid record energy costs, adding a further deterrent to consumer spending, already the weakest part of the region's economy.

Consumer prices rose 2.5 per cent from a year ago, the fastest pace since March 2002, the European Union's statistics office said, above the 2.3 per cent median forecast in a Bloomberg survey. Consumers were their least optimistic this year, and business confidence fell, surveys by the European Commission showed.

Concern about rising unemployment and pension costs has discouraged household spending, and higher gasoline prices are reducing the money available to spend on other goods and services. In contrast to the US and Japan, where household demand is helping to boost growth, European consumers are "very hesitant," European Central Bank Chief Economist Otmar Issing said on Thursday.

"There is some concern about the euro area economy," said James Knightley, an economist at ING Bank NV in London. "The pace of growth is not going to be as high as people had been expecting a few months ago."

The ECB, which aims to keep inflation close to and below 2 per cent, said this month it expects the annual increase in consumer prices to exceed its ceiling "over the short term." Oil prices are 26 per cent higher than the US$31.10 a barrel assumed by the commission in its economic forecasts, increasing the risk that growth will not reach the 1.7 per cent pace forecast this year.

Commission forecast

A 25 per cent increase in gasoline prices calculated in euros would reduce growth by 0.2 percentage points and increase inflation by 0.2 percentage points in 2004, the commission estimates.

ECB council members Klaus Liebscher and Jaime Caruana agreed on Thursday it is too early to say whether rising oil prices will make the ECB revise its growth and inflation forecasts.

The ECB has not touched borrowing costs since June, when it cut its benchmark rate to 2 per cent, the lowest in any euro country for six decades. Officials will meet next week to set rates.

Friday's report "doesn't really alter the outlook of steady rates from the ECB for a long time to come," Knightley said.

The euro fell against the dollar after the inflation report. The currency was down 0.3 per cent at US$1.2227 at 4:15 pm in Brussels on Friday, erasing an earlier gain of as much as 0.3 per cent. The euro's 4.6 per cent decline from a February 18 record has exacerbated the gain in oil costs, which are priced in dollars.

Stocks fall

European stocks also fell on concern about the effect of higher energy prices on the economy.

The Dow Jones Stoxx 50 Index dropped 0.6 per cent to 2673.39 points at 4:15 pm on Friday, erasing an earlier increase of 0.5 per cent.

Oil prices have surged more than 20 per cent this year, driving up inflation across the region. The inflation rate in Germany rose to the highest in more than two years in May, the government said on Tuesday. Spain's inflation rate rose to a 14-month high of 3.4 per cent, the country's statistics office said on Friday.

Accelerating inflation may be weighing on sentiment among companies and households. Business confidence fell to minus 5 from minus 4 as production expectations and order books fell, a commission survey of 25,000 companies showed. An index based on the same number of households showed consumer confidence slid to minus 16 from minus 14 on concern about employment and growth.

Consumer expectations for price trends over the next 12 months rose to 10 from 3, the survey showed, the highest level of concern about future inflation in the past year. Consumers plan to save more over the next 12 months, and are making less major purchases at present, the commission said.

US spending

In the US, the world's biggest economy, personal spending rose 0.3 per cent in April, more than economists had expected, a government report showed on Friday. The US inflation rate rose to 2.3 per cent in April from 1.7 per cent in March.

The euro region's economy expanded at the slowest pace in a decade in 2003 and is still trailing growth in the US and Asia. The economy grew 0.6 per cent in the first quarter. While that was the fastest in three years, it compares with comparable rates of 1.1 per cent in the US and 1.4 per cent in Japan.

Oil prices reached record of US$41.72 a barrel on the New York Mercantile Exchange on Monday. Deutsche Lufthansa AG, Europe's third-biggest airline, said this week it will raise the oil surcharge at its cargo unit by 25 per cent starting on June 7 to offset "the continued rise in the cost of crude oil and crude-oil products on the world market."

High energy prices may highlight splits on the ECB's 18-member governing council between those led by Issing who focus their analysis on inflation risks, and others alert to the dangers to the economy, according to economists including Dominique Barbet of BNP Paribas SA in Paris.

'Divergent opinions'

"We will continue to see divergent opinions between those which have a monetarist approach, who will want a strict approach to inflation, and others who see that rising petrol prices have a temporary effect on inflation and the more durable effect is on purchasing power," Barbet said.

Accelerating inflation and expectations that the US Federal Reserve will raise interest rates next month have wiped out talk of an ECB rate cut, future trading shows.

The yield on the three-month interest-rate futures contract for September rose two basis points to 2.18 per cent on Friday, up from 1.85 per cent March 26.

(China Daily 05/31/2004 page12)