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European Central Bank policy makers said fighting inflation will remain the bank's priority even as economic growth falters.

“We have to do everything to reach our price-stability goal,'' ECB governing council member Klaus Liebscher told reporters in Vienna today. “I don't think that yesterday's increase in interest rates will hurt the economy.'' His colleague on the governing council, Jose Manuel Gonzalez-Paramo, said the bank needs “to act as necessary at every moment to prevent second-round effects.''

The ECB increased its benchmark rate by a quarter point to 4.25 percent yesterday to counter inflation, which is running at the fastest pace in more than 16 years. The ECB is weighing the risk that higher rates will exacerbate an economic slowdown against the danger that faster inflation will feed into wages and prices.

Surging food and energy prices pushed inflation in Europe to 4 percent last month. The ECB aims to keep the rate just below 2 percent. Oil prices doubled in the past year and reached a record of $145.85 a barrel this week.

The ECB is concerned that companies will raise prices to pass on soaring raw-material costs and unions will push through bigger wage deals to compensate workers for the increased cost of living, leading to more persistent inflation.

Inflation Expectations

European labor costs rose 3.3 percent in the first quarter from a year earlier, the most in almost five years. Inflation expectations, as measured by the so-called breakeven on five- year French inflation-indexed bonds, were at 2.71 percent today, up from 2.12 percent in March.

“When we realized there was deterioration in the medium- term inflation expectations, the decision to increase rates was necessary,'' Italy's Mario Draghi said in a speech in Mirandola, Italy.

“If these expectations are consolidated in the system, we're lost,'' Gonzalez-Paramo said.

The policy makers nevertheless played down prospects of an imminent further rate increase, saying the quarter-point move yesterday will help bring inflation back below 2 percent.

Liebscher and Gonzalez-Paramo said the bank never pre- commits to its future path of monetary policy.

Another Increase

Investors are pricing in another quarter-point increase to 4.5 percent by the end of March next year, Eonia forward contracts show.

At the same time the economic outlook is deteriorating. Manufacturing orders in Germany, Europe's largest economy, unexpectedly declined for a sixth straight month in May, a report showed today. The last time orders fell for five consecutive months or more was in 1992. The German economy shrank the following year.

Industrial production in Spain fell the most in six years in May, another report showed. In June manufacturing in the 15 nations in the region contracted, a survey of purchasing managers showed July 1.

While expansion will be “significantly weaker'' in the second quarter and risks to growth “remain tilted to the downside,'' economic fundamentals are “healthy,'' Liebscher said. “We still stick to the baseline assumption of moderating but ongoing growth.''

The ECB on June 5 lowered its economic-growth forecast for next year to 1.5 percent from 1.8 percent. The bank expects the economy to expand 1.8 percent in 2008, down from 2.6 percent last year.

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