Inflation enters dangerous territory in the European Union--and I don't see it stopping here

01/06/2011 12:44 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Talk about getting caught between a rock and rocking the entire European Union.

Inflation kicked up to an annual rate of 2.2% in December in the European Union. That’s well above the European Central Bank’s oft-stated target of an annual rate “close but below” 2%.

In normal times, the European Central Bank, drawing on the remaining DNA from its ancestors at Germany’s Bundesbank, would raise interest rates to clamp down on inflation faster than you can say “Johannes Robinson.”

But these aren’t normal times. The bank is fighting to keep debt crises in Greece, Ireland, Portugal, and Spain from becoming a European Union wide financial and economic crisis. And there’s no way that the European Central Bank can raise interest rates to fight inflation—and therefore slowing the economy—when growth is already so anemic that any drop would provoke an even deeper crisis.

All signs say that the bank will grit its teeth and put up with higher inflation. That’s not going to sit well with the sizeable minority of the bank’s governors that have even before this data release urged that the bank cut back on buying the debt of hard-pressed European governments and banks.

And if you think this number will raise tensions, just you wait. The trends point to even higher inflation by February when the inflation number could rise to an annual 2.5% rate according to Barclay’s Capital.

That forecast seems almost certain to be right since the euro debt crisis will continue to depress the value of the euro, which will lead to higher prices—in euros—for food and fuel imports, the two biggest sources of the current rise in European inflation. Higher inflation, in turn, will push up European interest rates, worsening the debt crisis, and produce an even weaker euro.

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