Europeans raise key interest rate
Posted on Friday, July 4, 2008
URL: http://www.nwanews.com/adg/Business/230484/
The European Central Bank raised interest rates Thursday to a seven-year high to fight inflation even as the economy cools.
The bank’s Governing Council, meeting in Frankfurt, Germany, increased the benchmark lending rate by a quarter of a point to 4. 25 percent, as predicted by all but one of 58 economists in a Bloomberg survey.
Policymakers say they’re worried that the fastest inflation in 16 years will develop into a wage-price spiral as workers demand more pay to compensate for rising costs. The risk is that higher interest rates will deepen Europe’s economic downturn. France and Spain have already said the European Central Bank may not be paying enough attention to the growth outlook.
“The inflation outlook has deteriorated significantly in the past month,” said Klaus Baader, chief European economist at Merrill Lynch and Co. in London.
Investors have fully priced in another quarter-point rate increase to 4. 5 percent by the end of the year and most expect a third step by March, Eonia swap contracts indicate.
“It is our strong determination to keep medium- and long-term inflation expectations anchored in line with price stability,” ECB President Jean-Claude Trichet said Thursday in Frankfurt.
Central banks from Russia to Brazil are raising rates as inflation replaces the global credit crunch as their biggest concern. Indonesia moved Thursday for the third time in as many months and Sweden lifted its benchmark rate to a 12-year high.
“If we’re not decisive, there’s a risk of inflation exploding,” Trichet told the German newspaper Die Zeit in an article Wednesday.
Record food and energy prices pushed inflation in Europe to 4 percent this month, twice the European Central Bank’s 2 percent limit. Producer prices jumped a record 7. 1 percent in May from a year earlier.
Oil prices have doubled over the past year and breached $ 145 a barrel for the first time Thursday, fanning inflation concerns.
Still, with faster inflation sapping purchasing power and further damping the growth outlook, Trichet said last month that some of the European Central Bank’s 21 policymakers were against raising rates.
“I expect a rather balanced statement from Trichet,” said Gertrud Traud, chief economist at Helaba Trust GmbH in Frankfurt. “The [European Central Bank ], even though it sees the risk of inflation, is also under pressure to take responsibility for economic growth.”
European Central Bank Executive Board member Lorenzo Bini Smaghi said June 17 that one quarter-point rate increase “should be enough” to rein in inflation. Spain’s Miguel Angel Fernandez Ordonez has expressed concern about “contractionary trends” in his economy, which grew at the slowest pace in 13 years in the first quarter.
“I am not convinced it is prudent to significantly raise interest rates at this stage,” French Finance Minister Christine Lagarde said in an interview with BFM Television last week.
“The division in the Governing Council has never been bigger,” said Uwe Angenendt, chief economist at BHF-Bank AG in Frankfurt. “I see a small risk of the [European Central Bank ] raising interest rates again in September. But I generally expect a marked economic slowdown followed by rate cuts.”
Economists expect the bank to start cutting borrowing costs in June next year, another Bloomberg News survey shows.
Euro-region economic growth will slow to about 1. 8 percent this year and 1. 5 percent in 2009 from 2. 6 percent last year, according to European Central Bank forecasts. European manufacturing and service industries contracted in June.
In addition to higher costs, companies are grappling with the euro’s 17 percent appreciation against the dollar in the past year, which makes their exports less competitive.
The euro has been boosted by the widening interest-rate gap between Europe and the U. S., where the Federal Reserve lowered rates seven times since mid-September to fend off a recession. The U. S. housing slump made banks reluctant to lend, pushing up credit costs worldwide.
At the same time, “apprehension is growing that inflation expectations are on the rise,” Bundesbank President and European Central Bank council member Axel Weber, an advocate of higher interest rates, said June 25. “This is chiefly true for shortterm to medium-term inflation expectations, which cover the relevant time horizon of monetary policy.”
Inflation expectations, as measured by the break-even point on five-year French inflation-indexed bonds, jumped to a record 2. 82 percent Thursday from 2. 12 percent in March.
Unions are already pushing through bigger pay claims. European labor costs rose 3. 3 percent in the first quarter from year earlier, the most in almost five years.
While trying to damp speculation that the European Central Bank is embarking on a “series” of rate increases, Trichet has left open the option of further moves.
“I said that we could increase rates by a small amount in order to secure a solid anchoring of inflation expectations,” Trichet told the European Parliament in Brussels, Belgium, on June 25. “I didn’t say that we could envisage a series of increases. That being said, of course we never pre-commit.” Information for this article was contributed by Richard Weiss, Simone Meier, Judith Bogner and Simon Kennedy of Bloomberg News.