July 3, 2008 | posted by Michael Baxter in Eurozone, rate of interest |

Inflation in the Eurozone hit a new all-time high in June, with the HCIP rate coming in at 4 per cent.

And yet, just like in the UK and US, core inflation, that’s the inflation central bankers are supposed to worry about, is still modest.  The official data does not yet provide details on how the June inflation figures are broken down into regions and into core and headline inflation.   But Capital Economics reckons core inflation, that’s with food and energy taken out, is around 18 per cent.

But while the Fed and Bank of E talk about how they expect inflation to drop back later in the year, the European Central Bank president Jean-Claude Trichet told Die Welt newspaper that unless the bank takes action “inflation could explode.”

He added: “After having carefully examined the situation, we could decide to move our rates a small amount in our next meeting in order to secure the solid anchoring of inflation expectations, taking into account the situation… I don’t say it’s certain. I say it’s possible.”

Today we will know, but most seem to expect a Eurozone rate increase.

But Jean-Claude’s hawk-like pose has not endeared him to Eurozone politicians.

When Nicholas Sarkozy made his maiden speech to the European parliament back in November, he laid into the bank, and talked about removing its independence unless it became more open and accountable. Or, in other words, unless it independently concludes it agrees with the French premier, its independence is perhaps not such a good idea.

Yet, there is a good reason for the ECB to be tougher on inflation than Bernanke and King.

In the Eurozone, it appears the labour market is far more rigid.  Job losses are harder to enforce, demand for wage increases harder to resist.

In a way, Mr Sarkozy’s soft tone on inflation says it all.  In some parts of the Eurozone, although not Germany, inflation is not seen as the threat it is here.

This means the ECB has to compensate.

There is no evidence yet of mounting wage inflation in the UK or the US.  That is why central banks still feel quite sanguine about inflation in those two countries. 

But the rise in headline inflation leading to higher wages remains a very real threat in the Eurozone.

And that is why the Eurozone interest rate is likely to rise a lot further yet, and may even go above the UK rate in the next year or so.