ECB Raises Rate to 4.25%

The ECB's Governing Council, meeting in Frankfurt, increased the benchmark lending rate by a quarter point to 4.25 percent today to fight inflation even as the economy cools., Bloomberg 7/3/2008 6:52:51 AM

Policy makers say they're worried that the fastest inflation in 16 years will develop into a wage-price spiral as workers demand more pay to compensate for rising costs. The risk is that higher interest rates deepen Europe's economic downturn. France and Spain have already said the ECB may not be paying enough attention to the growth outlook.

Investors have fully priced in another quarter-point rate increase to 4.5 percent by the end of the year and most expect a third step by March, Eonia swap contracts show.

Trichet, who said last month a July rate increase was ``possible,'' holds a press conference at 2:30 p.m. to explain today's decision.

Central banks from Russia to Brazil are raising rates as inflation replaces the global credit crunch as their biggest concern. Indonesia moved today for the third time in as many months and Sweden lifted its benchmark rate to a 12-year high.

Record food and energy prices pushed inflation in Europe to 4 percent this month, twice the ECB's 2 percent limit. Producer prices jumped a record 7.1 percent in May from a year earlier.

Oil prices have doubled over the past year and breached $145 a barrel for the first time today, fanning inflation concerns.

Still, with faster inflation sapping purchasing power and further damping the growth outlook, Trichet said last month that some of the ECB's 21 policy makers were against raising rates.

ECB Executive Board member Lorenzo Bini Smaghi said June 17 that one quarter-point rate increase ``should be enough'' to rein in inflation. Spain's Miguel Angel Fernandez Ordonez has expressed concern about ``contractionary trends'' in his economy, which grew at the slowest pace in 13 years in the first quarter.

Economists expect the bank to start cutting borrowing costs in June next year, another Bloomberg News survey shows.

Euro-region economic growth will slow to about 1.8 percent this year and 1.5 percent in 2009 from 2.6 percent last year, according to ECB forecasts. European manufacturing and service industries contracted in June.

In addition to higher costs, companies are grappling with the euro's 17 percent appreciation against the dollar in the past year, which makes their exports less competitive.

The euro has been boosted by the widening interest-rate gap between Europe and the U.S., where the Federal Reserve lowered rates seven times since mid-September to fend off a recession. The U.S. housing slump made banks reluctant to lend, pushing up credit costs worldwide.

Inflation expectations, as measured by the breakeven on five- year French inflation-indexed bonds, jumped to a record 2.82 percent today from 2.12 percent in March.

Unions are already pushing through bigger pay claims. European labor costs rose 3.3 percent in the first quarter from year earlier, the most in almost five years.

While attempting to damp speculation that the ECB is embarking on a ``series'' of rate increases, Trichet has left open the option of further moves.






ECB Raises Rate to 4.25%