Frankfurt: The European Central Bank (ECB) raised interest rates for the seventh time since late 2005 to stem inflation after the fastest economic growth in six years.
ECB policy-makers meeting in Frankfurt on 8 March increased the benchmark refinancing rate by a quarter point to 3.75%, as expected by all 38 estimates in a Bloomberg News survey. The Bank of England (BoE) kept rates unchanged on Thursday.
While economists expect another step from ECB in June, investors have pared bets on a further increase.
ECB has indicated it wants to curb inflation in the 13-nation euro region by removing “monetary accommodation” and taking rates to a level that no longer stimulate the economy.
With inflation below the bank’s 2% limit and the economy showing signs of cooling, some investors say the central bank has reached that point today.
“The key will be whether they continue to describe monetary policy as ‘accommodative’,” said Guillaume Menuet, senior European economist at Merrill Lynch International in London. “That’s a sign they’ve left the door open to another increase.”
ECB president Jean-Claude Trichet will hold a press conference to explain Thursday’s decision at 2:30 p.m. in Frankfurt.
Interest rate futures and the euro’s exchange rate were little changed after the decision. The implied rate on the three- month Euribor futures contract for September was 4.05% at 1:55 pm in Frankfurt. It was 4.16% on 22 February.
According to the central bank, the contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 16 basis points more than ECB’s key rate since the single currency’s start in 1999. Europe’s single currency was worth $1.3150 (Rs57.86).
Much will hinge on ECB’s new economic forecasts, due to be published on Thursday. If they suggest inflation will accelerate in 2008, the bank will be inclined to raise rates further, said Steve Webster, chief European economist at 4Cast Ltd in London.
ECB currently forecasts inflation of about 2% this year and 1.9% in 2008.
Policy-makers are “still concerned about a resurgence in inflation later this year”, said Webster. “They will raise rates to 4% in June unless we get some catastrophic volatility in markets.”
Global equity markets are recovering from a sell-off that wiped $3.3 trillion off stock values around the world in six days.
That was caused in part by concern that growth in the US economy, the world’s largest, is slowing.
Waning demand for exports and a higher sales tax in Germany may crimp euro-region economic expansion this year. Retail sales in Germany, Europe’s largest economy, plunged 5.1% in January from a month earlier and factory orders unexpectedly dropped 1% as export demand declined.
Still, with the expansion accelerating more than economists expected in the fourth quarter of 2006, ECB may revise up its growth estimate for this year, ECB council member Nicholas Garganas suggested in an interview published on 27 February.
The bank currently projects expansion of about 2.2% this year after 2.6% in 2006, which was the fastest growth since 2000.
The European Commission on 16 February forecast a slowdown to 2.4% in 2007.
The economy “is on a solid, stable growth path”, ECB council member Axel Weber said on 28 February. “We must therefore further withdraw monetary stimulation from the economy.”
Economists say the so-called neutral interest rate, the level that neither stimulates nor restrains growth, lies between 3.5% and 4%.
Inflation slowed to 1.8% in February, holding below 2% for the sixth straight month and putting the central bank on course to achieve its inflation goal in 2007 for the first time since 1999.
The bank is concerned workers’ demands for wage increases will reignite inflation as companies post record sales and profits.
IG Metall, Germany’s biggest labour union, is demanding a 6.5% pay increase for as many as 3.4 million workers, defying ECB calls for wage restraint.
At the same time, M3 money supply—the total amount of money within an economy— which ECB uses as a gauge of future inflation, rose 9.8% from a year earlier in January, the fastest pace in 17 years.
“The risks to inflation are clearly on the upside, and are growing,” Garganas said.
“How far do you need to go with rates when you know that stronger growth hasn’t so far translated into stronger inflation?” said Sandra Petcov, an economist at Lehman Brothers International in London.
“We expect hawkish language from the ECB, but it’s not ready yet to signal what it will do next.”