Euro Zone inflation higher than expected

Euro zone inflation was higher than expected in December, exceeding the European Central Bank's target for the first time in two years, but economists believe the bank will keep interest rates unchanged well into 2011.

The European Union's statistics office Eurostat estimated that prices in the 16 countries that shared the euro currency in December rose 2.2 per cent year-on-year, up from 1.9 per cent in November.

It was highest year-on-year rate since October 2008, when it came in at 3.2 per cent. Economists polled by Reuters had expected inflation of two per cent. The ECB wants to keep price growth at just below two per cent.

Eurostat does not provide a monthly figure or a detailed breakdown with its estimate, which will come on 14 January.

But economists said the rise in inflation was mainly due to energy and food price rises. BNP Paribas economist Clemente de Lucia, said that between December and November oil prices rose by around seven euros per barrel, the strongest monthly increase in more than two years.

Year-on-year oil prices were up by more than 18 euros, which probably boosted energy prices by around 10 percent year-on-year, de Lucia said.

"This commodity-price driven rise in inflation will only have implications for ECB policy if the central bank were to see second round effects emerging, in terms of knock-on effects on other prices or rising inflation expectations," said Nick Kounis, head of macroeconomic research at ABN AMRO bank.

"That only seems likely if we were to see a long period of high inflation, but on the basis of current levels of commodity prices, we think that inflation will ease back down again during the course of this year," Kounis said.

In November it was more expensive energy, especially fuels for transport, heating oil and gas, that was the main driver of inflation.

But economists said that excluding price-driving effects of the tax hikes implemented in many countries, the inflation rate would have been some tenths lower.

Further adjusted for volatile energy prices, the underlying inflation would be no more than around 1 percent, they said.

"There is no need for monetary policy to act, with underlying inflation still at one per cent. We continue to expect the ECB to start hiking rates only in 2012," said Christoph Weil, economist at Commerzbank.

But other economists said the ECB could raise the costs of borrowing earlier.

"We are predicting inflation of two per cent in 2011 and that means that keeping interest rates at historical lows will no longer look appropriate," said Thomas Mayer, Deutsche Bank's chief economist.

"We think that the ECB will have to move interest rates upwards in the second half of the year. It is the beginning of a careful normalisation," he said.