Thursday June 8, 8:24 PM
ECB tightens rates to 3-year high
By Krista Hughes
MADRID (Reuters) - The European Central Bank raised interest rates by a quarter percentage point to a three-year high of 2.75 percent on Thursday, a move that marked the third increase in euro zone borrowing costs since December.
Inflation accelerating further above the ECB's target, economic growth near its long-term trend rate and signs of a pick-up in consumer spending all contributed to market expectations of tighter monetary policy.
Fifty of 52 analysts polled by Reuters earlier this week had predicted the increase from 2.50 percent, where rates had been since the bank's March meeting.
Slumping equity markets and a strengthening euro, however, had meant the ECB was unlikely to go for a chunky half percentage-point rise, but rates are nonetheless now at their highest level since early March, 2003.
The euro weakened slightly against the dollar on the news, dropping to $1.2730 from $1.2764 previously and debt prices also fell. This pushed up yields on the interest-rate sensitive two-year government note to 3.419 percent from 3.405 percent before. Bund futures also fell, down to 116.18 from 116.27 before the decision.
The focus is now on ECB President Jean-Claude Trichet, who holds a news conference explaining the rate decision at 1230 GMT in Madrid, where the Governing Council held one of its twice-yearly policy meetings away from the ECB's Frankfurt home.
ECB watchers are looking for any hint on whether the ECB might step up its so-far quarterly pace of rate increases, and for revised 2006 and 2007 growth and inflation forecasts.
"Last night Trichet commented that 'inflation expectations' are solidly anchored and we would expect him to endorse that sentiment today," said Julian Callow, economist at Barclays Capital after the decision.
"In our view, if the ECB wants to raise rates at a quicker pace that once a quarter, it would be inclined to move to once every two months, bringing early August into play."
However, the ECB faced pressure from politicians before Thursday's meeting who encouraged it to step carefully in raising rates to avoid fuelling a euro rally, which could hurt export-driven growth in the 12-nation region.
But at a dinner before the meeting central bankers stressed the ECB has only limited powers to deliver strong economic growth through monetary policy, saying politicians have work to do too.
"The speed limit is not in our hands. The speed limit is in the hands of those responsible for structural reforms," Trichet said.
The Bank of England also met on Thursday and left its key rate at 4.5 percent.
NERVOUS MARKETS
Markets are extremely jittery about the shifting sands of global monetary policy. Hawkish comments from U.S. Federal Reserve officials this week sent stock markets reeling on the view that it will continue its two-year string of increases.
In Asia, the Bank of Japan could begin raising rates from zero as early as July, although doubts are also growing there as Tokyo stocks plunge.
If the ECB were to signal in its policy statement that an acceleration in the pace or size of hikes is coming, the stock and bond market declines could accelerate.
Certainly the ECB could build a strong argument to justify firm treatment ahead. Inflation jumped to 2.5 percent in May. Service sector prices hit their highest level in over five years in June. Private lending in April soared to an 11.3 percent annual rate, the strongest since monetary union in 1999.
Howard Archer, European economist at Global Insight, said growing inflationary pressures set the stage for very hawkish remarks from Trichet. "Indeed the ECB may well indicate that it is prepared to tighten monetary policy more aggressively in the future," he said.
A critical hint to future rate moves will be the updated staff economic forecasts due out later on Thursday. Inflation is now projected around 2.2 percent for 2006 and 2007 and analysts in a Reuters survey expected them to remain constant.
Higher inflation forecasts would be troubling because for the first time staff models will incorporate market expectations on the future path of short-term rates. Such projections would suggest more aggressive increases may be needed.