Tags: EU | Europe | Interest | Rates

ECB Raises Key Interest Rate to 1.25% to Stem Faster Inflation

Thursday, 07 Apr 2011 07:52 AM

The European Central Bank raised its key interest rate by a quarter point Thursday, underlining its determination to fight rising inflation even as several euro member countries struggle to get their debts under control.

A day after Portugal finally accepted defeat in its battle to avoid a financial bailout, the ECB raised its refinancing rate to 1.25 percent from a record low of 1 percent, where it had been since May 2009.

The move highlights the dilemma facing the central bank as it tries to set a single monetary policy for a region that spans 17 different economies.

On the one side, Portugal is set to join Greece and Ireland in taking a rescue package and Spain is struggling with a 20 percent unemployment rate. On the other, countries like Germany are enjoying robust growth, booming exports and falling unemployment.

But because the European Central Bank's mission is to control inflation, it is tightening policy, even though that will put more pressure on hard-hit consumers with mortgages and the collapsed real estate markets in the so-called peripheral countries. Many argue that the U.S. Federal Reserve has more leeway as it has a dual mandate, that also includes jobs creation.

Bank President Jean-Claude Trichet said keeping inflation in check would benefit all members, including the ones with troubled finances. The key for those countries was to fix their government finances and improve the prospects for their economies, as required by bailout agreements with the European Union and the International Monetary Fund.

"We have a number of countries which have to correct their situation, particularly on the fiscal side, not only the fiscal side, but economic policy in general," he said. "Plans are in place and they have to apply the plan."

Economist Clemens Fuest of the Said Business School at Oxford University said that the bank had to tread a path between the weak periphery and the stronger "core" — France and Germany — as it returns interest rates to a more normal level.

"I think the effect will be more to send a clear signal that the ECB is determined to prevent inflation expectations from increasing too much," Fuest said. "It's symbolic but important."

Trichet did not commit to a series of increases, but left the door open for what analysts think will be several more by the end of the year. "We did not decide that it was the first of a serious of rate increase," he said, adding that each month "we always do what is necessary to deliver price stability."

He did not, however, express the need for "strong vigilance" against inflation -- a term regarded as a signal to markets that rates are going up the next month. Instead, he said the bank would "monitor very closely" the risks of rising prices, which he said "remain on the upside" — phrasing that seemed to leave the bank room to pause for a month or two before acting again.

The ECB is worried that inflation, which hit 2.6 percent in March, will remain stuck above its target of "close to, but just under 2 percent." Critics of a rate hike have noted that inflation has been mainly driven by higher oil and food prices, largely external factors the ECB cannot control through its policies.

Trichet said the bank was determined to move pre-emptively to keep higher prices from causing a spiral effect in which higher inflation expectations cause wages to go up, in turn boosting consumer prices further.

The ECB is charting a different course from the U.S. Federal Reserve, which has not yet signaled readiness to begin raising rates from the current rock-bottom 0-0.25 percent.

The Bank of England's monetary policy committee left rates untouched at 0.5 percent at its meeting Thursday even though inflation in Britain is running at 4.4 percent.

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The European Central Bank raised its key interest rate by a quarter point Thursday, underlining its determination to fight rising inflation even as several euro member countries struggle to get their debts under control. A day after Portugal finally accepted defeat in its...
EU,Europe,Interest,Rates
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2011-52-07
 

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