Moreover, employment rates and labour force participation have increased significantly in recent years, and unemployment rates have fallen to levels not seen for 25 years. However, these developments, which support household disposable income and consumption, are unlikely to fully compensate the loss of purchasing power caused by higher energy and food prices. In the view of the Governing Council, the uncertainty surrounding this outlook for economic activity remains high, owing not least to the very high levels of commodity prices, and downside risks prevail. In particular, risks stem from the dampening impact on consumption and investment of further unanticipated increases in energy and food prices.
Moreover, downside risks continue to relate to the potential for the ongoing financial market tensions to affect the real economy more adversely than anticipated. Concerns about the emergence of protectionist pressures and the possibility of disorderly developments owing to global imbalances also imply downside risks to the outlook for economic activity.
With regard to price developments, annual HICP inflation has remained well above the level consistent with price stability since last autumn, reaching 3.7% in May 2008 and - according to Eurostat's flash estimate - 4.0% in June. This worrying level of inflation rates results largely from sharp increases in energy and food prices at the global level in recent months. Looking ahead, on the basis of current futures prices for these commodities, the annual HICP inflation rate is likely to remain well above 2% for quite some time, moderating only gradually in 2009. We are thus currently experiencing a protracted period of high annual rates of inflation, which is likely to be more persistent than anticipated some months ago.
Risks to price stability at the policy-relevant medium-term horizon remain clearly on the upside and have increased further over the past few months. These risks include notably the possibility of further increases in energy and food prices. There is also a very strong concern that price and wage-setting behaviour could add to inflationary pressures via broadly based second-round effects. The Governing Council is monitoring price-setting behaviour and wage negotiations in the euro area with particular attention. Furthermore, there are potential upside risks from unanticipated rises in indirect taxes and administered prices.
Against this background, it is imperative to ensure that medium to longer-term inflation expectations remain firmly anchored at levels in line with price stability. The shift in relative prices and the related transfer of income from commodity-importing countries to commodity-exporting countries have to be accepted. They require a change in the behaviour of companies and households. Therefore, broadly based second-round effects stemming from the impact of higher energy and food prices on price and wage-setting behaviour must be avoided. All parties concerned, in both the private and the public sector, must meet their responsibilities in this regard.
In this context, the Governing Council is concerned about the existence of schemes in which nominal wages are indexed to consumer prices. Such schemes involve the risk of upward shocks in inflation leading to a wage-price spiral, which would be detrimental to employment and competitiveness in the countries concerned. The Governing Council therefore calls for such schemes to be avoided.“
