ECB raises key rate to 1.50%, faces dilemma over ratings

FRANKFURT: The European Central Bank raised its main interest rate on Thursday for the second time since April but markets are now focused on how it will avoid a collision with ratings agencies over Greece.

The ECB raised its benchmark lending rate to 1.50 percent to contain eurozone inflation that now stands at 2.7 percent, following a rate increase in April which was its first since July 2008.

In London, the Bank of England kept its key interest rate at a record low 0.50 percent and was expected to maintain the status quo into next year owing to Britain's flagging recovery, economists said.

Analysts now want to see if the ECB will raise rates further this year and how it will tackle the latest twist in the eurozone debt crisis, after Moody's slashed its rating on Portugal to junk status and Standard & Poor's warned a proposal to help Greece could lead to a "selective default."

The central bank says it cannot accept Greek bonds as collateral in loan operations if Greece defaults but unless the bank is willing to risk a collapse of Greek banks, the ECB might be forced into a compromise.

So far however, proposals to have private investors join in a rescue plan all run the risk that one or more of the leading ratings agencies will declare that Athens is effectively in default on its debt obligations.

Given that the ECB has backtracked twice on Greece already, with the purchase of sovereign bonds and the dumping of standard collateral criteria, a third about face could do substantial damage to the bank's reputation.

Berenberg Bank senior economist Christian Schulz told AFP after the rate decision he wanted to see first if there was any wording in an ECB statement read during a press conference on the outlook for another rate hike this year.

Then, he wanted to hear if ECB president Jean-Claude Trichet indicated "any kind of softening of the rules of the ECB regarding eligibility of collateral."

The ECB is already at odds with European politicians over how to involve private investors in plans to aid Greece.

German junior finance minister Joerg Asmussen has said Berlin could revive a proposal to swap existing Greek bonds into longer maturity ones, an idea the

ECB rejected when it was first floated.

Ernst & Young senior economist Marie Diron felt the ECB and ratings agencies would "meet somewhere in the middle."

For all concerned, "what is really at stake is their credibility," she told AFP.

If rating agencies decide Greece has defaulted on its debt for only short periods, the ECB could approve emergency liquidity assistance (ELA) that has already been extended to banks in Ireland.

Without ECB loans, the Greek banking sector would most probably crumble like a house of cards.

Goldman Sachs economist Natacha Valla suggested the central bank "may well make 'technical' adjustments to the definition of 'eligibility' at some stage, so as to remain able to accept Greek paper without this being seen as a capitulation."

Diron said: "Deep down I think everyone would agree that Greece is defaulting, or restructuring its debt, however you call it.

"This restructuring or default needs to be managed in as orderly a way as possible" to avoid contagion to other debt-stricken eurozone countries like Ireland and Portugal.

On Wednesday, European Union leaders slammed ratings agencies for the downgrade and warning about the financial prospects in Portugal and Greece.

The agencies' comments and especially their timing plunged the eurozone into fresh turmoil as finance ministers tried to stitch together a second bailout for Greece.

The euro has fallen below 1.43 dollars and the cost of borrowing for

Portugal has shot up, pulling up rates for Spain and Italy as well.

"We must break the oligopoly of the ratings agencies," German Finance

Minister Wolfgang Schaeuble said.

He also wanted to "break" their power and "limit" their influence.

Ratings agencies are nonetheless being consulted by European politicians to determine if their proposals will pass market muster.

ING senior economist Carsten Brzeski told AFP: "I think it’s in the interest of everyone, at least the politicians and the ECB, to come up with a scheme that is not a default, and if this requires involvement of the ratings agencies, so be it."

Copyright AFP (Agence France-Presse), 2011