ECB keeps interest rates on hold

The European Central Bank left its benchmark interest rate at a record low of 1.0 percent today despite a heavy cloud of inflation loomed over the 17-nation eurozone.

ECB policymakers acknowledged the threat but said they feel it should recede later in 2011, which is when most analysts expect the bank's first rate hike since July 2008.

In January, eurozone inflation jumped to 2.4 percent, above the ECB target of below but close to 2.0 percent.

Yesterday the latest reading of producer prices showed they had leapt by 5.3 percent on an annual basis, the sharpest increase since October 2008.

Although producers' costs were undoubtedly affected in large part by energy prices -- crude oil has spiked to $103 a barrel on fears over knock-on effects of the turmoil in Egypt -- the trend in eurozone inflation is also clearly upwards.

While economists don't expect an ECB rate hike for several months, they have begun to speculate on the kind of language bank president Jean-Claude Trichet will use in his post-decision press conferences to signal when it will come.

"It is likely that the ECB will start to introduce a range of expressions to prepare financial markets for the first rate increase, some time in the second half of this year," said Marie Diron at the business consultancy Ernst & Young.

This time around however, "we do not expect a wording change to signal the ECB is close to an early rate hike," RBS counterparts Jacques Cailloux and Nick Matthews added in a research note.

Trichet will certainly comment on the latest price data however, since he regularly highlights the bank's success in achieving its inflation target.

Many western central banks have held lending rates at ultra-low levels to keep credit flowing to recovering economies, but now face a situation that could call such policies into question.

In Britain, where the Bank of England has held its main rate at a record low of 0.50 percent, BoE governor Mervyn King has also warned that annual inflation could reach between four and five percent in the coming months.

Higher energy and food prices are the main drivers of inflation but tax hikes approved by governments to reduce excessive debt are pushing up costs for businesses and households as well.

That could lead to higher wage demands, which would worry ECB governors but which some economists feel would be appropriate in some countries, to sustain eurozone growth with support from beyond the industrial sector.

"If you want to get a broadening of the recovery, I think you need to accept higher wages in Germany" for example, ING senior economist Carsten Brzeski told AFP.

Consumers across the eurozone show continued reluctance to hit the high streets, and retail sales fell by 0.6 percent in December from the previous month and by 0.9 percent on a 12-month basis according to EU data released on Thursday.

"Many consumers have significant worries about their long-term positions," IHS Global Insight's chief European economist Howard Archer commented.

The eurozone economy is slowly growing as a whole, but there is wide split between dogged recessions in Greece and Portugal and expanding business activity in Germany and elsewhere

One positive sign emerged last week when the European Financial Stability Facility, an aid mechanism for heavily-indebted eurozone governments, staged a very successful bond issue to raise funds for Ireland.

The ECB wants the EFSF to be strengthened and allowed to buy bonds issued by eurozone governments, a role currently assumed with increasing reluctance by the central bank.

Tomorrow, EU leaders are expected to outline a broad programme of reforms to protect against future debt crises and show they are getting to grips with the issue.