Central banks go on offensive against inflation

NEW YORK/PARIS (Reuters) - Central bankers on both sides of the Atlantic escalated their verbal offensive against inflation on Tuesday, sparking a rise in the U.S. dollar and falls in stock and bond prices.

The central bankers' comments came against the backdrop of growing consumer discontent over soaring food and fuel prices, with protesters marching in Asia over soaring oil prices and Spaniards stockpiling fuel and food due to a truck drivers' strike over high oil prices.

In Europe, Erkki Liikaken, a Finnish member of the European Central Bank's rate-setting Governing Council, said the euro zone's central bank was in a state of "heightened alertness" over inflation" and that a rate rise in July is possible though not certain.

In the U.S., Dallas Federal Reserve President Richard Fisher also indicated that soaring prices were a bigger threat than a weak economy, saying he would pay the price of weaker economic growth if that kept inflation in check.

"We want to make sure the message is clear ... that we will not countenance building inflationary expectations," Fisher said in a speech in New York.

The Bank of Canada also signaled its concern about inflation and surprised markets by keeping its key interest rate steady at 3.0 percent, implying an end to its rate-cutting cycle.

WHIP INFLATION NOW

The central bankers' anti-inflation campaign was highlighted late Monday when U.S. Federal Reserve Chairman Ben Bernanke reiterated the Fed's mission to prevent soaring fuel and food costs from raising consumer expectations of ongoing prices rises.

Surprisingly, Bernanke played down the problems of a U.S. economy hit by a housing market slump and kept the focus firmly on inflation given oil prices are near all-time highs.

"Although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so," Bernanke told a conference in Boston.

"The latest round of increases in energy prices has added to the upside risks to inflation and inflation expectations," he said.

As rising fuel prices fanned the fears of inflation, the U.S. government's top energy forecaster on Tuesday raised its projections for 2008 oil prices by nearly 12 percent.

The U.S Energy Information Administration said benchmark West Texas Intermediate oil prices would average $122.15 a barrel, up from its previous forecast of $109.53 a barrel.

Last Friday crude oil prices on the New York Mercantile Exchange reached a record $139.12 a barrel.

European Central Bank chief Jean-Claude Trichet, who shocked markets last week with an announcement that ECB rates could rise in July, also reiterated his comments on Monday.

"What I said was entirely inspired by this necessity to anchor inflation expectations," he told a forum in Paris on Monday, referring to last Thursday's news conference when the ECB president announced that a rate rise was possible next month if not a certainty.

Other officials were also preoccupied with putting a strangle-hold on inflation now, before expectations of accelerated price rises become embedded in the global economy.

ECB Governing Council member Athanasios Orphanides said on Tuesday that inflation expectations are a primary consideration for central banks, especially when policy-makers face difficult choices.

ECB Governing Council Member Axel Weber made similar comments, adding that monetary policy had to act in a forward-looking manner in order to ensure price stability over the medium term.

"It has become evident that expected future inflation is a crucial determinant of actual future inflation," Weber said.

G8 TO FOCUS ON INFLATION

Politicians joined the fray too ahead of a meeting in Japan where food and fuel price inflation is expected to dominate the debate among G8 finance ministers -- from the United States, Japan, Germany, Britain, France, Italy, Canada and Russia.

"I think we need to take very seriously the concerns that have been expressed by the central bank (ECB)," German Deputy Finance Minister Thomas Mirow told reporters before heading to the G8 meeting in Osaka.

U.S. Treasury Secretary Henry Paulson said on Tuesday it was "critical" for China to adopt a more flexible currency regime if it expects to protect its thriving economy from runaway inflation.

Over the weekend, China again raised bank reserve ratios to restrict bank lending and control inflation running at about 8.0 percent, leading Chinese stocks to fall more than 7.0 percent on Tuesday.

Financial markets in Europe and the Americas continued to take the threat of inflation seriously, with bond yields rising ahead of likely central monetary policy tightening, even though the economic outlook is poor in the industrial world.

World stock prices slid, major government bonds tumbled and the U.S. dollar got a lift as the markets bought into the idea that the Fed could raise its federal funds rate by as much as 0.75 percentage points this year to damp inflation pressures.

(Additional reporting from Reuters bureaux in Washington, Paris, Tokyo, Berlin, Rome and Helsinki;)