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Europe's central bank likely to raise key rate next month

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An official says higher oil prices and wage pacts are contributing to inflationary pressures.

May 11, 2007|From the Associated Press

With inflation a concern amid strong economic growth, the European Central Bank signaled Thursday that it would lift its key interest rate next month, while the Bank of England raised rates in Britain to their highest level in six years.

Officials of the European bank, meeting Thursday in Dublin, Ireland, agreed to hold their benchmark rate at 3.75%.

But Jean-Claude Trichet, the bank's president, said "strong vigilance" was warranted to defend the current cost of living in the euro zone -- a phrase he has used before each of the central bank's seven quarter-point hikes since December 2005.

Trichet cited the risk of higher oil prices and wage agreements. Germany's IG Metall union claimed a major victory this month when it reached an agreement with industrial employers to increase wages 5.8% over 19 months.

"It is crucial that the social partners meet their responsibilities so as to continue to avoid wage developments that would eventually lead to inflationary pressures and harm the purchasing power of all euro area citizens," Trichet said.

European monetary officials, who last raised rates in March, must balance the competing interests of fighting inflation versus making life tolerable for exporters, who could be hurt by the euro's near-record high versus the U.S. dollar.

Getting the balance right in recent years has encouraged solid economic growth throughout the 13-nation euro zone, which is home to 318 million people and accounts for more than 15% of global economic output.

However, some countries such as France are concerned that the strong euro will make exports more costly, particularly to buyers who pay in dollars.

The euro hit a record of $1.3682 on April 27 but has since retreated. On Thursday it fell to $1.351 from $1.353 on Wednesday in New York.

The Bank of England's move to raise rates by a quarter-point to 5.5% was widely anticipated after three increases since August apparently failed to cool inflationary pressures and a buoyant housing market.

Inflation in Britain jumped in March to an annual rate of 3.1% from 2.8% in February.

The bank's monetary policy committee said lower energy prices would help bring inflation to its target of 2% sometime this year.

With economic growth strong in the euro area and unemployment dropping, analysts broadly agree that the Europeans will raise their key rate to 4% next month. Opinion is divided about whether that will be as high as the rate goes.

Dan McLaughlin, chief economist of the Bank of Ireland, predicts that the rate won't top 4%.

"The central bank can't just keep raising rates," he said, "because it risks precipitating a serious slowdown."

McLaughlin noted that the central bank had forecast inflation averaging 2% in 2008. The bank's target is just under 2%.

"Strictly speaking," he said, "you could ask them: 'Why are you raising rates at all?' "

Others said they expected the central bank to raise rates at least twice more in 2007, maintaining its recent pattern of hikes every three months.

*

(BEGIN TEXT OF INFOBOX)

Benchmark rates

Key short-term rates of the world's major central banks

*--* Australia 6.25% Britain 5.5 U.S. 5.25 Canada 4.25 Europe 3.75 Japan 0.5

*--*

Source: Bloomberg News

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