Thursday, April 7, 2011

ECB Raises Interest Rates

ECB Raises Interest Rates

By NINA KOEPPEN And TODD BUELL

FRANKFURT—The European Central Bank on Thursday raised its benchmark interest rate to 1.25% from a historic low of 1%, as expected, making it the first of the developed world's major central banks to initiate a cycle of raising rates.

The move, which marks the ECB's first rate rise since July 2008, comes despite the deepening debt crisis in the euro zone's periphery, after Portugal on Wednesday became the third nation in the 17-country bloc to ask for a financial bailout from the European Union.

Markets and observers will now turn to the ECB's monthly press conference, where ECB President Jean-Claude Trichet will give clues as to how the bank will proceed along its monetary-policy path.

Mr. Trichet is expected to argue that a significant build-up of inflationary pressure across the euro zone justifies the rate increase. Inflation in the region hit a 29-month high of 2.6% in March, and it is widely forecast to accelerate further in the coming months, to about 3% in June. That's well above the ECB's objective of keeping inflation "below, but close to" 2% over the medium term.


But, at the same time, he is likely to tone down the hawkish rhetoric that marked March's press statement. He is expected to omit the "strong vigilance" phrase traditionally used to signal an upcoming rate rise.

If Mr. Trichet were to keep the "strong vigilance" phrase, markets would know that the ECB means business in its efforts to combat inflation. In practical terms, another rate increase could then come as early as May.

But it's more likely that the ECB chief will take a step down on the hawkometer by saying that the Governing Council will monitor "very closely" all developments over the period ahead. This would mean that rates will stay unchanged until June, at least.

Mr. Trichet is expected to stick to his inflation assessment, namely that "risks to the medium-term outlook for price developments are on the upside."

Maintaining that rhetoric would reinforce that the ECB remains "alert," or "permanently alert"—other catch phrases he likes—against the backdrop of tightening price pressures.

Some economists say Mr. Trichet may reintroduce the remark that interest rates are "appropriate." Observers knew that something was amiss when he dropped that comment at the March press conference after it had been a mainstay of his opening statements since the main refinancing rate settled at 1% in May 2009.

Bringing it back would suggest the central bank has taken an assertive step now to combat inflation, but that its next tightening move might not come for another couple of months.

The ECB president may have more announcements in store. He may unveil a new plan to keep struggling banks afloat over the medium term. A number of banks, especially from Ireland but also from Greece and Portugal, are heavily dependent on central-bank funding.

Write to Nina Koeppen at nina.koeppen@dowjones.com

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