Global inflation rise puts central banks in a fix

BERLIN (Reuters) - Global inflation pressures intensified at the start of this year, combining with slower growth to put central bankers in a bind about how to keep prices in check without tipping their economies into recession.

In the United States, where the Federal Reserve has slashed interest rates since a global credit crunch gripped the economy last August, data on Friday showed the Fed's favored gauge of underlying U.S. inflation rose by 0.3 percent in January after a 0.2 percent gain in December, while the overall annual rate rose to 3.7 percent from 3.5 percent.

In the euro zone, where the European Central Bank has so far declined to follow the Fed's rate-cutting lead, preliminary data for several countries in February showed inflation holding well above the ECB's 2 percent target ceiling in major economies.

February inflation was running at an annual rate of 2.9 percent in Germany, at 3.1 percent in Italy, and at a record 4.4 percent in Spain. In Belgium, inflation jumped to 3.64 percent -- the highest rate since July 1991.

In Japan, annual inflation held at a decade-high 0.8 percent in January, but with other data pointing to an economic slowdown, the Bank of Japan was still seen potentially cutting rates from an already very low 0.5 percent this year.

Ken Wattret, chief euro zone market economist at BNP Paribas, said the euro zone was likely to see uncomfortably high levels of headline inflation in the coming months.

"The ECB is caught in a very awkward position, which is that the economic growth outlook is deteriorating, and deteriorating fast in my opinion, but inflation is not getting better quickly enough," he said.

European Central Bank Governing Council member Axel Weber said on Wednesday market expectations that the ECB will cut interest rates from the current 4 percent fail to consider the dangers of higher inflation.

NO U.S. "STAGFLATION"

Federal Reserve Chairman Ben Bernanke said on Thursday the United States was not headed toward 1970s-style "stagflation" but acknowledged inflation could complicate efforts to spur the economy.

Friday's U.S. core personal consumption expenditure price index, or PCE, underlined the conflicting pressures on central banks to support growth as the banking sector reels from writedowns on high-risk debt, while seeking to hold inflation in check.

The Fed, which has already cut rates by 2.25 percentage points to 3 percent since last September, is widely expected to keep cutting.

"Data shows that inflation pressures are beginning to uptick, but this is not going to change the view the next move by the Fed will be an interest rate cut," said Matthew Strauss, currency strategist at RBC Capital in Toronto.

In updated economic forecasts released last week, the U.S. central bank lowered its outlook for 2008 growth by a half point to between 1.3 percent and 2 percent, citing the prolonged housing slump and bottlenecks in credit markets.

In Japan, much stronger-than-expected housing construction and household spending data released on Friday eased some concern that Japan may follow the United States into recession.

The Japanese central bank has been looking for inflation to return after years of battling deflation.

"The price trend will be similar in all developed countries. Inflation is high at the moment, but it will ease in the future," said Yoshimasa Maruyama, an economist at BNP Paribas in Tokyo.

In Europe, the ECB's task has been made harder by a series of above-inflation pay demands from trade unions in Germany, the region's largest economy, which the central bank fears could shift up inflation expectations and feed further wage demands.

However, the ECB is also wrestling with a weakened euro zone growth outlook. A business climate indicator for the euro zone, based on a survey of corporate managers, fell more than expected in February to its lowest level in two years.

CORE EURO ZONE INFLATION EASES

A breakdown of euro zone January price data showed core inflation, which excludes volatile energy and food costs, eased to 1.7 percent in January from 1.9 percent in December. The preliminary euro zone figure for February is due on March 3 and was being forecast at an unchanged 3.2 percent.

"The fact that core inflation remains muted should give the ECB some leverage to start easing rates very soon," said David Brown, chief European economist at Bear Stearns.

The headline euro zone inflation rate accelerated to 3.2 percent in January from 3.1 percent in December.

Wattret at BNP Paribas thought the ECB would soon look beyond the headline inflation rate and focus on the risks to growth in the euro zone, where a rise in the euro to a record high versus the dollar is making life hard for exporters.

Most economists in the latest Reuters poll expect the ECB to cut rates twice this year, but think any imminent move looks less likely as inflation stays high.

(Editing by Ruth Pitchford)