3rd UPDATE: Trichet: Continued Inflation Risk In Medium Term

   (Adds more market reaction.) 
 

FRANKFURT -(Dow Jones)- European Central Bank President Jean-Claude Trichet warned Thursday of continued inflation risk in the medium term despite signs of a weakening euro-zone economy.

The ECB announced earlier Thursday that its governing council left the central bank's chief policy rate unchanged at 4.25%.

Trichet said the Thursday decision to hold rates unchanged was unanimous.

"The information that has become available since the last meeting has confirmed that annual inflation levels are likely to remain high," Trichet told a news conference.

Financial markets logged mixed reviews of Trichet's commentary. European stocks lost ground on perceptions that the ECB was holding to its status quo of curbing inflation.

Trichet said it was important for the central bank to keep down inflation expectations, ascribing signs of a stalling euro-zone economy in the second quarter to the comparison effect with a strong first quarter, as well as to such global factors as high energy prices.

This suggests that the bank's current policies continue to contribute to keeping down prices, he said.

Trichet, however, noted a slowing in corporate and household demand for credit as economies slowed, but still warned of the inflation threat of rising wages and producer prices.

"We have in this domain a very, very strong goal for avoiding those effects and making the point that not only would it create a big problem for delivering price stability...but it would also play against employment," Trichet said.

Preventing a new inflation push remains the bank's "absolute priority," he said. But Trichet also said the bank's governing council currently had no policy bias.

"We will continue to monitor very closely all developments in the months ahead," Trichet said.

European bond markets focused on Trichet's remarks on increasing risks for economic growth, and that the ECB's current policy stance will help achieve its anti-inflation objectives.

The comments tended to underpin market expectations that, while the ECB's inflation concerns clearly prevail, the next move in euro-zone interest rates will be down because of slowing economic trends.

The September German benchmark bund contract initially extended earlier price gains, testing technical resistance around the contract high of 114.96 as investors anticipated falling yields.

Trichet dodged suggestions that the euro-zone could be edging toward a recession, however.

"I said we would have a trough in the second and third quarter," he said. Afterwards, he said, "we will have a progressive recovery."

Later in the European afternoon, markets focused more on Trichet's concerns about inflation risks instead of his observations on the weakening economy, which were reflected in a downward revision to economic forecasts by the ECB economics staff.

European stocks extended losses as investors digested the day's news. The Dow Jones Eurostoxx 50 index was down 0.9% at 3335.9 towards the end of Trichet's news conference.

"He has confirmed the status quo and does not expect to change his policy," said economist Rainer Guntermann at Dresdner Kleinwort. "Their projections are catching up with consensus, but it looks like interest rates will be held in the near term."

-By Monica Houston-Waesch and Nina Koeppen, Dow Jones Newswires; +49 69 29 725 520; nikki.houston@dowjones.com

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(END) Dow Jones Newswires

September 04, 2008 10:25 ET (14:25 GMT)


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