June 24, 2024

European Central Bank Makes First Rate Hike Since 2008

FRANKFURT — Worried about rising prices, the European Central Bank raised its benchmark interest rate for the first time since 2008 on Thursday, risking damage to weaker economies like Portugal, which only a day ago became the third country to request an international bailout.

A short time earlier, Britain’s central bank left its benchmark interest rate at 0.5 percent despite similar inflation concerns, after recent economic data painted a mixed picture of the strength of Britain’s recovery. The central bank also kept its bond-purchase plan at £200 billion, or $325 billion.

But the E.C.B. is taking a more hard-line approach in raising its rate to 1.25 percent from the historic low of 1 percent, where it has been since the depths of the global financial crisis. The bank president Jean-Claude Trichet and other members of the governing council had warned repeatedly over the past month that they were worried that higher oil prices would fuel a general increase in prices.

Many economists and political leaders said that a rate increase for the euro zone was premature and unnecessary, arguing inflation is not a problem when factories are still not operating at full capacity, and that higher inflation is solely the result of volatile commodity prices.

“We cannot see what good purpose raising interest rates now will accomplish,” Carl B. Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y., wrote in a note this week.

The E.C.B. move will hurt Greece, Ireland and Portugal when they are already having severe problems borrowing money at reasonable rates, critics said. Portugal’s caretaker government gave in to market pressures on Wednesday and joined Greece and Ireland in seeking an emergency bailout.

The rate increase will also raise monthly mortgage payments in countries like Spain and Ireland where many people have variable-rate loans.

However, a rate increase will be welcomed by individuals and companies who keep their money in savings accounts or low-risk investments, and have been earning interest below the rate of inflation.

Lorenzo Bini Smaghi, a member of the E.C.B. governing council, has argued that a rate increase would actually hold down long-term borrowing costs, by giving lenders confidence that inflation will not erode their profits.

Analysts expect the rate increase Thursday to be the first of two or three such hikes before the end of the year. Mr. Trichet will hold a press conference at 2:30 p.m. Frankfurt time, where he is likely to be asked how fast the E.C.B. will push rates back to more normal levels.

Economists at Nomura forecast that the next increase will come in July, and that the benchmark rate will reach 2.75 percent by the end of 2012, still a low rate by historical standards. But the E.C.B. could also hold off on further increases if there are signs that higher energy prices are becoming a drag on European growth.

“Any signs that the recovery is significantly losing momentum will likely make the E.C.B. pause its rate-hiking cycle,” Nomura economists said in a note Tuesday.

The E.C.B. may also say Thursday how it will deal with weaker banks in countries like Ireland, Greece and Germany that have become overly dependent on cheap central bank loans to finance their activities. Mr. Trichet and other governing council members have said they want to remove the financial system from life support, and avoid the risk of asset bubbles or other problems caused by too much cheap money.

In a break from the historic pattern, the E.C.B. is moving to slow the economy and head off inflation ahead of the Federal Reserve. More than the American central bank, the E.C.B. is required by charter to make fighting inflation its top priority.

E.C.B. resolve was probably strengthened by recent data. Inflation in the euro area rose at an annual rate of 2.6 in March, up from 2.2 in February and above the E.C.B. target of just under 2 percent.

The E.C.B. last raised its benchmark rate to 4.25 percent from 4 percent in July 2008. The following October, as the financial crisis took on alarming proportions, the E.C.B. reversed course and began a series of cuts that brought the benchmark rate to 1 percent in May 2009.

Rates in Britain also fell to a record low, but the Bank of England rate is likely to wait for more data at the end of this month before making any decision to lift interest rates, economists said.

Britain’s central bank fears that raising interest rates too soon could damage an already weak economic recovery. Some economists said consumers are still getting used to government spending cuts, which are coming into force this month, as well as higher taxes and oil prices. That made it harder for the Bank of England’s policymakers to judge whether the economy is strong enough to withstand an increase in interest rates.

Alan Clarke, an economist at BNP Paribas in London, said a rate increase by the E.C.B. could put additional pressure on the Bank of England to raise its own rate because it could weaken the pound. “A weaker pound in our recent experience has led to higher inflation,” he said.

The Bank of England had been trying to balance an inflation rate that is the highest since 2008 with economic growth that remains slow. In a meeting last month, central bank officials said that there was “merit” in waiting to see how the government’s austerity program, which includes thousands of public sector job cuts, would affect the economy.

Recent economic data renewed some concern that Britain is still struggling after shrinking 0.5 percent during the last three months of 2010. Britain’s manufacturing sector stopped to grow in February and overall industrial production fell unexpectedly. Yet, the services sector grew at its fastest pace in 13 months in March.

The average price of houses was little changed in March as potential buyers delayed decisions because of concerns about economic growth and as higher consumer prices hurt disposable incomes.

Julia Werdigier contributed reporting from London.

Article source: http://feeds.nytimes.com/click.phdo?i=2e226b16f9fd1020365d6ca670dd10c1

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