May 24, 2024

European Bank Raises Rate for 1st Time Since 2008

Jean-Claude Trichet, the E.C.B. president, argued that the bank needed to attack inflation even though many economists believe that raising borrowing costs could damage weaker economies like Portugal, which only a day earlier became the third country in the euro area to request an international bailout.

With what sometimes sounded like contrarian pride, Mr. Trichet said that the rate increase was perfectly in tune with economic growth.

“There is no contradiction, but full complementarity in doing what is our prime mandate, which is to deliver price stability,” he said at a news conference after a meeting of the governing council of the E.C.B. “We do what we have to do even when it is difficult, even when it is not necessarily pleasing everyone.”

Asked by an Irish reporter what he would say to families in Ireland who will now have to make higher payments on their adjustable-rate mortgages, Mr. Trichet said low inflation “benefits all, including, of course, those who have the most difficulty at the present.”

The increase in the benchmark policy rate to 1.25 percent from 1 percent puts the E.C.B. at odds with the Federal Reserve, which continues to stimulate the U.S. economy, as well as the Bank of England, which on Thursday left its benchmark interest rate at 0.5 percent, despite an increase in inflation.

The E.C.B.’s decision, which Mr. Trichet said was unanimous on the 23-member governing council, drew muted praise from places like Germany, where the rate increase could help prevent the economy from overheating. But the reaction from other quarters was sometimes scathing.

The rate increase could have dire consequences for Greece, Ireland and Portugal when they are already having severe problems borrowing money at reasonable rates, some economists said. Portugal’s caretaker government gave in to market pressures on Wednesday and joined Greece and Ireland in seeking an emergency bailout.

“Tighter monetary policy will only add to the burden of reeling peripheral countries and increase the risk of a much worse debt crisis,” Marie Diron, a former E.C.B. economist who now advises the consulting firm Ernst Young, said in a note Thursday. “We hope that this rate hike is not the start of a series of rate increases that would seriously endanger the fragile recovery.”

Michael T. Darda, chief economist at MKM Partners, a research firm in Stamford, Connecticut, said the E.C.B. was repeating the same mistake that the Fed made in the 1970s and 1980s, when it responded to higher oil prices by raising rates, and, instead, created recessions.

“Those recessions were not oil-induced but Fed-induced,” said Mr. Darda, citing an academic paper by Ben S. Bernanke, now the Fed chairman, that criticized Fed policy at the time.

Though interest rates are still low by historical standards, they are high in relation to Europe’s stuttering growth rate, Mr. Darda said.

“The ultimate effect is that they are going to restrain inflation in Germany and France but will cause deflation in the periphery, which will cause austerity programs to fail,” Mr. Darda said by telephone. “This could very well spread into Spain and Italy.”

Mr. Trichet said that a rate increase would hold down long-term borrowing costs, by giving lenders confidence that inflation would not erode their profits.

The Bank of England faces similar inflation concerns, but left its main policy rate alone after recent economic data painted a mixed picture of the strength of Britain’s recovery. It also kept its bond-purchase plan at £200 billion, or $325 billion.

Not all economists were so critical of the E.C.B. move.

“Fear that this step by the E.C.B. will lead to a worsening of the crisis in the peripheral countries is overdone,” Michael Heise, chief economist at the German insurer Allianz, said in a note to clients. Even if the E.C.B. raises the rate to 2 percent by the end of the year, real interest rates would still be lower than inflation, he said.

In light of strong German growth, the “rate decision was without doubt logical,” Karl-Heinz Boos, executive director of the Association of German Public Sector Banks, said in a statement, though he added that the E.C.B. should be cautious about raising rates further.

And Mr. Trichet suggested that another rate increase soon was not a foregone conclusion. “We did not decide today that it was the first of a series of interest rate increases,” he said. Analysts interpreted his remarks to mean that the E.C.B. might wait several months before raising rates again.

Article source:

Speak Your Mind