European Central Bank says rate may rise

Jean-Claude Trichet, president of the European Central Bank The European Central Bank signaled Thursday that it could raise interest rates as soon as next month in response to intensifying inflationary pressures. Such a move would be likely to lead soon to higher borrowing costs for homeowners and businesses. An interest rate increase would be the first by a top central bank to prevent the recent effects of higher oil and food prices from spreading into the broader economy. But it could add to the troubles of countries like Ireland, Greece and Portugal and, if continued, would probably further weaken Europe’s economic growth prospects this year. “An increase of interest rates in the next meeting is possible,” Jean-Claude Trichet, president of the central bank, said Thursday at a news conference in Frankfurt. The next policy meeting on setting rates is set for April 7.
If interest rates rise, private banks are likely to respond by pushing up their own mortgage and deposit account rates, crimping spending power for many consumers but benefiting savers. Mr. Trichet emphasized, however, that such an increase was “not certain” and that it should not be seen as “the start of a series of interest rate increases.” The comments surprised most analysts, who had not expected that the bank would raise rates until later in the year. They had expected it to announce that it would scale back some of its temporary measures intended to provide added liquidity for struggling banks. “This is about as clear a signal of a rate hike that you are going to see from a central banker,” said Nick Kounis, head of economics at ABN Amro in Amsterdam. “The E.C.B. is once again living up to its reputation as a single-minded inflation fighter.”
Earlier, the bank decided to leave its benchmark rate at 1 percent, the record low it has held since May 2009. Mr. Trichet said that the decision was unanimous. The euro climbed after Mr. Trichet’s comments, rising to $1.3959 late in the day in New York, from $1.3860 late Wednesday, as investors anticipated higher returns on euro zone securities relative to those in the United States, Britain and Japan, where interest rates of central banks remained below 1 percent. The central bank has a narrow mandate focusing on inflation, unlike the Federal Reserve, which has a mission that includes the “pursuit of maximum employment.” The E.C.B.’s official comfort zone for inflation is just below 2 percent. Yet annual inflation in the euro zone hit 2.4 percent in February, its highest level since October 2008 and up from 2.3 percent in January, according to estimates this week from Eurostat, the European statistics agency. Recent increases in commodity prices, notably oil — the benchmark Brent crude futures contract has risen more than 20 percent this year — suggest to many analysts that inflation has further to rise. Food prices are also climbing. The Food and Agriculture Organization of the United Nations said Thursday in Rome that its food price index was up 2.2 percent last month from January, reaching the highest level in inflation-adjusted and nominal terms since the agency started monitoring prices two decades ago. Higher food prices have been a factor behind unrest in North Africa and the Middle East, which in turn has pushed oil prices higher. Mr. Trichet said that the recent increase in inflation largely reflected commodity prices and that there had not yet been evidence of its passing through to wages. “It is essential that the recent rise in inflation does not give rise to broad-based inflationary pressures over the medium term,” he said. “Strong vigilance is warranted with a view to containing upside risks to price stability.”
While the central bank is acting against cost pressures, there is still evidence that economic activity in the region is patchy. Eurostat confirmed this week that growth was slower than expected in the fourth quarter of 2010. Gross domestic product in the euro zone, which had 16 countries in 2010, grew 0.3 percent in the fourth quarter compared with figures in the third quarter. The three biggest economies — Germany, France and Italy — expanded more slowly than expected. Some countries like Portugal and Greece are still contracting, saddled by debt and lacking competitiveness relative to their peers. Mr. Trichet responded by saying, “Our responsibility is for 331 million people.” Those representing consumers and unions expressed frustration at the central bank announcement. “The dynamics set in motion by a hike will cause problems,” said Ronald Janssen, chief economist the European Trade Union Confederation. A rate increase appears logical for Germany, where growth is solid and unemployment is falling, he added, but not for Ireland, Spain and Greece, where consumers are struggling under the pressure of tough austerity policies, higher oil prices and low wage settlements. “It highlights a fundamental problem for the euro zone, that monetary policy is not adequate for all its members,” Mr. Janssen said. “The real question that needs to be addressed is how to go toward a fiscal union. But politicians are trying to avoid it.”
Several members of the central bank’s governing council have been sounding the alarm about acting quickly and decisively against inflation. One possible successor to Mr. Trichet after his retirement at the end of October — Mario Draghi of the Bank of Italy — has himself issued such warnings recently. Most analysts now expect the bank to raise rates by a quarter of a percentage point next month. “Mr. Trichet seems to be suggesting that monetary tightening can be gradual in the coming months,” Mr. Kounis of ABN Amro said. “The message seems to be that an early start does not necessarily imply a more aggressive tightening cycle.” Still, there is no guarantee of that. Around the turn of 2006, the central bank made similar statements of caution but then proceeded to push rates up by two percentage points over the next 18 months.