A tough decision but one that makes sense from their perspective. The Bernanke Fed does not like it because they do not have the same latitude, and must take the risks of unleashing a further decline in the dollar, despite brave talk and faked statistics.
ECB Raises Benchmark Rate to Seven-Year High to Fight Inflation
By Christian Vits
July 3, 2008 07:46 EDT
July 3 (Bloomberg) -- The European Central Bank raised interest rates to a seven-year high to fight inflation even as economic growth cools.
The ECB's Governing Council, meeting in Frankfurt, increased the benchmark lending rate by a quarter point to 4.25 percent today, as predicted by all but one of 58 economists in a Bloomberg survey.
Policy makers 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 deepen Europe's economic downturn. France and Spain have already said that the ECB may not be paying enough attention to the growth outlook.
``The ECB is choosing the lesser of two evils,'' said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. ``We fear that oil prices and inflation will create the need to raise interest rates further.''
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 show.
ECB President Jean-Claude Trichet, who said last month a July rate increase was ``possible,'' holds a press conference at 2:30 p.m. to explain today's decision.
`Exploding' Inflation
Central banks from Russia to Brazil are raising rates as inflation replaces the global credit crunch as their biggest concern. Indonesia moved today 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 German newspaper Die Zeit in an article released yesterday.
Record food and energy prices pushed inflation in Europe to 4 percent this month, twice the ECB'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 today, fanning inflation concerns.
Still, with faster inflation sapping purchasing power and further damping the growth outlook, Trichet said last month that some of the ECB's 21 policy makers were against raising rates.
One `Should Be Enough'
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 ECB 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 ECB forecasts. European manufacturing and service industries contracted in June.
Euro's Appreciation
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 ECB council member Axel Weber, an advocate of higher interest rates, said June 25. ``This is chiefly true for short-term to medium-term inflation expectations, which cover the relevant time horizon of monetary policy.''
Inflation expectations, as measured by the breakeven on five- year French inflation-indexed bonds, jumped to a record 2.82 percent today 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 attempting to damp speculation that the ECB 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 on June 25. ``I didn't say that we could envisage a series of increases. That being said, of course we never pre-commit.''
To contact the reporter on this story: Christian Vits in Frankfurt at cvits@bloomberg.net
