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Europe's central bank lifts key rate

Policymakers suggest they may tighten further to stem inflation amid a pickup in growth.

March 09, 2007|From Bloomberg News

The European Central Bank on Thursday raised its benchmark short-term interest rate for the seventh time since 2005 and left open the possibility of another increase to stem inflation, amid the region's fastest economic growth in six years.

But the widely expected move failed to upset European stock markets, which continued to rebound from last week's slide.

Central bank policymakers raised their key rate from 3.50% to 3.75%, a five-year high.

"Given the favorable economic environment, our monetary policy continues to be on the accommodative side," President Jean-Claude Trichet told a news conference in Frankfurt.

Although he described the new rate as "moderate" -- a change from previous comments that labeled European rates as "low" -- Trichet said that " 'moderate' doesn't mean 'appropriate,' " and added, "I didn't say we were at a peak" in rates.

"Trichet's language suggests we're going to see another rate increase to 4%, probably in June," said James Nixon, director of economics at Societe Generale in London. "He retained all the phrases that suggest the bank still has a tightening bias."

The euro-region economy expanded at a real rate of 2.6% in 2006, the fastest since 2000. The central bank is concerned that inflation will accelerate with growth.

The bank on Thursday raised its mid-point economic growth projections for 2007 and 2008 to about 2.5% and 2.4%, respectively, and predicted that inflation would accelerate to about 2% in 2008 from 1.8% this year.

Policymakers say their goal is to keep the rate of price increases below 2% a year.

The bank is fearful that workers' demands for wage increases will reignite inflation as companies post record earnings. IG Metall, Germany's biggest labor union, is demanding a 6.5% pay increase for as many as 3.4 million workers, defying calls for wage restraint.

"Risks to the medium-term outlook for price stability remain on the upside," Trichet said. "We will do whatever we judge necessary to counter inflation risks."

The European Central Bank's benchmark rate of 3.75% still is well below the 5.25% short-term rate maintained by the U.S. Federal Reserve. The Bank of England's rate also is 5.25%. Policymakers there met Thursday and held their rate steady.

European stock markets were broadly higher despite the central bank's move. The German market jumped 1.4%, French shares were up 1.3% and the Italian market also gained 1.3%.

The euro eased against the dollar, ending in New York at $1.314, down from $1.318 on Wednesday.

Many investors worldwide have been expecting European interest rates to rise this year. By contrast, many on Wall Street have expected the Federal Reserve to hold its rate steady or begin cutting it.

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