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OT: European Central Bank Raises Rates

Thursday December 7, 9:32 am ET
By Matt Moore, AP Business Writer
European Central Bank Raises Its Key Interest Rate to 3.5 Percent

FRANKFURT, Germany (AP) -- The European Central Bank raised its key interest rate a quarter of a percentage point to 3.5 percent on Thursday, but a strong euro suggests the bank could pause after boosting rates six times over the past year.

The Bank of England, meanwhile, held its key lending rate steady at 5 percent.

European Central Bank President Jean-Claude Trichet said that "disorderly" movement by currencies on foreign exchange markets were undesirable, but did not say if the rising euro would pose a threat to monetary policy. Instead, he said that people should let the markets judge the euro's exchange levels.

With the 12-nation euro hovering around 20-month highs against the U.S. dollar, the ECB may feel pressure to back off future increases for fear of seeing the shared currency rise so high it stunts growth in the euro zone, which accounts for nearly 15 percent of the global economy.

Speaking after the bank announced its latest increase, Trichet said the bank will monitor inflation "very closely" in the coming months -- a signal that another increase next month was unlikely.

Brian Dolan, head of currency research at Forex.com, said Trichet's remarks had suggested there may not be any rate increases until February or March of 2007.

After Trichet's comments, the euro was fairly steady against the dollar. In afternoon European trading, the currency stood at $1.3290, up from $1.3285 in New York late Wednesday.

Trichet had all but signaled that the increase from 3.25 percent would come this week after the bank's last meeting in November, saying the Governing Council was using "strong vigilance" in regard to inflation.

All 51 economists surveyed by Dow Jones Newswires ahead of the announcement had expected the increase.

The Bank of England held its key interest rate steady at 5 percent on Thursday, a decision that was widely expected after increases in August and November took rates to the current five-year high.

The ECB started raising rates in December 2005, after the euro-zone's economy started picking up. The recovery has been broadly sustained, with demand for credit still strong in the 12-nation zone that has more than 313 million people.

But with the euro so strong -- about 3 cents off its all-time high of $1.3667 reached in December 2004 -- analysts are split about what the strength of the common currency could mean for rates through 2007.

Saxo Bank analyst Kristian Siggaard-Jensen said Trichet would be careful about predictions.

"Inflation expectations for 2008 are easing off, giving European policy-makers a comfort zone in terms of rate outlook," he said. "The (euro-dollar rate) has ticked up some 4 percent in recent sessions and Trichet does not want to give the market additional reason to buy up more."

Holger Schmieding with Bank of America expected the ECB to leave the rate outlook for early 2007 open, partly because it may not have reached a consensus and partly because it may not want to inflame currency markets.

As the euro rises, it can help curb inflation and ease pressure on the central bank to raise interest rates. But it can also hampers European exporters by making their goods more expensive in crucial foreign markets like the United States.

Higher rates tend to boost a currency, and the bank may feel pressure to back off future increases for fear of seeing the currency rise so high it stunts growth.

Worries over volatile oil and gas prices, an increase next month in Germany's value-added tax and a potential economic slowdown in the U.S. are other concerns the bank will have to juggle.

http://www.ecb.int