Inflation Has Eurozone in a Headlock

01/06/2011 3:53 pm EST

Focus: MARKETS

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 slow 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 sizable minority of the bank’s governors that has, 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.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of November. For a full list of the stocks in the fund as of the end of November see the fund’s portfolio here. I’ll have the fund’s portfolio as of the end of December posted in a few days.

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