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European Central Bank increases benchmark rate

July 04, 2008|From the Associated Press

The warnings from politicians and the unions were dire: Raise interest rates and it will hurt the economy and jobs. European Central Bank President Jean-Claude Trichet paid them no heed Thursday as the bank raised its benchmark rate a quarter of a percentage point.

The move made it clear that Trichet thinks inflation is the real threat, not slower growth. What he left hazy is where rates go next.

The bank's governing council raised its benchmark interest rate from 4% to 4.25%. Trichet said the meteoric rise of food and energy costs across the 15 countries that use the euro was disconcerting enough to prompt a unanimous vote in favor of the move.

It was the first move upward since June 2007, putting rates at a nearly seven-year high. It was also the first time the bank had adjusted the rate in either direction since August despite the global credit crisis. Higher rates fight inflation but can slow growth too.

"This decision was taken to prevent broadly based second-round effects and to counteract the increasing upside risks to price stability over the medium term," Trichet said. "Second-round effects" means a wage-price spiral, when wages rise to cope with rising costs, which in turn prompts companies to raise prices.

In contrast, the U.S. Federal Reserve began a series of rate reductions that started in September and extended through late April, cutting the key federal funds rate to 2% -- aggressive steps to shore up an economy bruised by the trio of housing, credit and financial crises.

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