ECB raises interest rates

The European Central Bank raised its key interest rate to a new five-year high of 3.75 percent on Thursday and signalled no immediate end to rate increases in the eurozone.
ECB President Jean-Claude Trichet told a news conference that while rates now are moderate, monetary conditions still support economic growth in the region and the Governing Council is ready to squelch inflationary pressures.
"Our monetary policy continues to be on the accommodative side, with the key ECB interest rates moderate, money and credit growth vigorous, and liquidity in the euro area ample by all plausible measures," Trichet said.
European government debt slipped on these comments, with Euribor futures pricing in a greater chance that ECB rates would continue climbing this year. But the euro currency lost some ground, seeing rates nearing a peak.
Trichet's description of interest rates as moderate marked a slight change in tune. Until now he has called eurozone interest rates "low", so the new language recognises that after 175 basis points of increases since December 2005, credit conditions are less stimulative.
However, Trichet allowed the bank some room over how monetary policy will unfold in the months ahead. He avoided saying that the ECB plans to step hard on the monetary brake to slow down growth and strangle inflationary pressures.
"If I was preparing the market for us being restrictive, I would have said that. I did not say that," he said. At the same time, he left the door open to further rate increases. "I did not say we were at a peak, full stop."
Market analysts said this language, combined with new projections for strong growth and inflation to climb again next year, suggest that ECB rates are heading to 4.0 percent and possibly higher.
"The ECB remains in a hawkish mode and maintains its implicit tightening bias, even though the bias appears to have softened a little," said Sandra Petcov, economist at Lehman Brothers in London.
2008 INFLATION TO WORSEN: ECB staff revised the inflation outlook for 2008 upward to a 2 percent midpoint from 1.9 percent forecast three months ago. This means the ECB sees a reasonable chance it would fail to meet its price stability goal of inflation just below 2 percent next year, unless it tightens monetary conditions further.
Staff also revised up slightly their projections for growth in the 13-nation region to 2.5 percent in 2007 and 2.4 percent in 2008, on the back of lower oil prices and strong economic momentum from the final quarter of 2006. Previously, they were at 2.2 percent and 2.3 percent respectively. These projections underline the likelihood that ECB rates will continue rising, analysts said.
"Rates have still not peaked at 3.75 percent. Judging by Trichet's latest intimations, the tightening bias remains in tact and the ECB rates should be heading to 4 percent as the next policy stop. Timing is the issue now," said David Brown, economist at Bear Stearns in London. Marco Valli, economist at Unicredit in Milan, agreed. "(There are) no signs they are planning on stopping at this level."