Trichet Leaves Door Open to More Interest-Rate Increases to Tame Inflation

Jean-Claude Trichet, president of the European Central Bank (ECB) Photographer: Antoine Antoniol/Bloomberg

 

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April 7 (Bloomberg) -- David Blanchflower, professor of economics at Dartmouth College and a former policy maker at the Bank of England, talks about the European Central Bank's decision to raise its benchmark interest rate a quarter percentage point to 1.25 percent and the impact on euro-zone economies and the region's sovereign-debt crisis. Blanchflower speaks with Margaret Brennan on Bloomberg Television's "InBusiness." (Source: Bloomberg)

 

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April 7 (Bloomberg) -- Lena Komileva, global head of G10 strategy at Brown Brothers Harriman Ltd., discusses the European Central Bank's decision to raise the benchmark interest rate to 1.25 percent from a record low of 1 percent. Komileva, speaking with Tom Keene on Bloomberg Television's "Midday Surveillance," also discusses the euro and U.S. economy. (Source: Bloomberg)

 

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April 7 (Bloomberg) -- James Nixon, co-chief European economist at Societe Generale SA, discusses today's European Central Bank rate decision. ECB policy makers meeting in Frankfurt today raised the benchmark interest rate for the first time in almost three years to 1.25 percent from a record low of 1 percent. Nixon speaks with Erik Schatzker and Deirdre Bolton on Bloomberg Television's "InsideTrack." (Source: Bloomberg)

European Central Bank President Jean-Claude Trichet left the door open for further interest-rate increases to tame inflation after raising borrowing costs for the first time in almost three years.

Inflation risks remain on the upside and the ECB’s monetary policy is still “accommodative,” Trichet said at a press conference in Frankfurt after lifting the benchmark rate by a quarter percentage point to 1.25 percent. While “we did not decide it was the first in a series of interest-rate increases, you know from our own doctrine that we always do what is necessary to deliver price stability over the medium term,” he said.

The ECB is balancing the need for tighter policy in countries like Germany, whose economy is booming, against the risk that higher rates could exacerbate the sovereign debt crisis afflicting peripheral euro-area nations. While bonds erased declines and the euro initially fell after Trichet’s comments as some investors pared bets on rapid rate increases, markets still expect the ECB to raise its benchmark to 1.75 percent by the end of the year, Eonia forward contracts show.

“Trichet retained a relatively hawkish tone but the market has already priced in so much and there was nothing in there to extend that theme,” said Jane Foley, a senior foreign exchange strategist at Rabobank International in London. Trichet “is paving the way for further rate rises but he’s also clearly unwilling to commit the Governing Council to pre-announcing rate hikes”

Yields Decline

The yield on two-year German notes, typically more sensitive to interest-rate expectations, fell as much as three basis points and was one basis point lower at 1.83 percent as of 2:56 p.m. in London. The euro, which fell as much as 0.6 percent, recouped its losses to trade at $1.43.

The ECB joins central banks in China, India, Poland and Sweden in raising interest rates even as the Federal Reserve remains reluctant to tighten amid divisions among its policy makers. The Bank of England and the Bank of Japan today left their key rates unchanged at 0.5% and 0.1% respectively.

Today’s ECB increase is the first since July 2008 and also the first time in 40 years that Europe’s benchmark has risen before the U.S. equivalent.

Inflation breached the ECB’s 2 percent limit in December and accelerated to 2.6 percent last month, the fastest pace in more than two years.

Broad-Based Pressures

While ECB officials acknowledge that surging energy and food prices are largely to blame, they’re worried that workers will demand higher wages in compensation, entrenching faster inflation.

“It is essential that recent price developments do not give rise to broad-based inflationary pressures over the medium term,” Trichet said.

The ECB has repeatedly been forced to delay the withdrawal of emergency policy settings enacted during the global financial crisis as Europe’s debt woes threatened to tear the 17-nation currency bloc apart. It is still providing banks with unlimited liquidity and has kept its bond-purchase program in place.

Portugal last night became the third euro-area nation after Greece and Ireland to succumb to the region’s debt crisis and seek a European Union bailout. Trichet said the ECB “encouraged Portugal to ask for support.”

German Strength

While nations such as Ireland and Spain are still buckling under debt burdens and burst property bubbles, Germany’s economy last year expanded 3.6 percent, the most since reunification two decades ago.

“The ECB is setting rates in relation to Germany,” said Vicky Pryce, managing director of FTI Consulting Inc in London and a former adviser to the U.K. government. “It’s a bold move, but a wrong one,” she said, adding Greece, Ireland, Portugal and possibly Spain “need a rate increase like a hole in the head.”

On aggregate, the region has returned to health. Euro-area growth will average 1.7 percent this year and 1.8 percent in 2012, according to ECB forecasts.

“Recent economic data confirm that the underlying momentum of economic activity continues to be positive,” Trichet said. “We will continue to monitor very closely all developments with respect to upside risks to price stability.”

The phrase “monitor very closely” was “used in the previous rate-hike cycle to signal that a hike could come as early as the meeting after next,” said Nick Kounis, chief European economist at ABN Amro in Amsterdam. “Our base scenario is that interest rates will rise again in July.”

Ken Wattret, chief euro-area economist at BNP Paribas SA in London, said the ECB could raise rates again as soon as June.

Trichet’s comment that the ECB hasn’t decided that today’s move is the start of a series of increases “is not the same as saying that it will not be one,” Wattret said.

To contact the reporters on this story: Gabi Thesing in London at gthesing@bloomberg.net; Jana Randow in Frankfurt at jrandow@bloomberg.net.

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net