The European Central Bank raised interest rates to the highest in more than two years to keep up its fight against inflation as the region’s sovereign debt crisis persists.
Officials meeting in Frankfurt today increased the benchmark interest rate by 25 basis points to 1.5 percent, matching forecasts by all 55 economists in a Bloomberg News survey. That’s the highest since March 2009. The central bank will raise borrowing costs further in October, according to a separate survey.
Policy makers are trying to balance the risks of further turmoil in debt markets against the danger that Germany’s export-led recovery will fuel a wage-price spiral. While the yield on Greek, Irish and Portuguese two-year bonds all exceed 15 percent, inflation across the region has breached the central bank’s 2 percent limit for the past seven months.
“We will see another rate increase before the end of the year because the inflation outlook warrants it,” said Laurent Bilke, head of inflation strategy at Nomura International Plc in London. “At this level, the impact on the periphery is marginal. That leaves Trichet with the freedom to really draw a line in the sand with governments and remind them that it’s their job to fix the crisis.”
Trichet holds a press conference at 2:30 p.m. in Frankfurt to explain today’s decision. The Bank of England today kept borrowing costs at 0.5 percent. In Sweden, the Riksbank raised its benchmark repurchase rate to 2 percent on July 5, the seventh increase in a year. The People’s Bank of China yesterday raised key rates for the third time this year.
European bond yields rose to a record on renewed concern that the debt crisis is spreading across the region after Moody’s Investors Services cut Portugal’s credit rating to junk on July 5. Trichet is at odds with European leaders over how to contain the debt crisis, saying it’s up to nations to plug budget gaps as policy makers fight price gains.
European finance ministers earlier this month authorized an 8.7 billion-euro ($12 billion) loan payout to Greece in an attempt to avert the region’s first sovereign default. Standard & Poor’s and Fitch Ratings have both indicated they would cut Greece to default if leaders went ahead with a plan to ask creditors to roll over expiring Greek bonds into new debt.
“We’re entering a more critical phase” and there’s “a lot of uncertainty in the market,” Christopher Pissarides, professor at the London School of Economics, told Bloomberg Television in an interview in Brussels yesterday.
While leaders are still seeking ways to fight the crisis, Europe’s recovery is already losing momentum. Services and manufacturing growth slowed more than estimated in June and economic confidence weakened. In Germany, Europe’s largest economy which has powered the region’s recovery, investor sentiment dropped to a 2 1/2-year low last month.
Weaker growth may help curb price pressures and prompt the ECB to raise interest rates less aggressively than investors and economists initially estimated, said Julian Callow, chief European economist at Barclays Capital in London.
“This may in fact be Trichet’s last interest-rate increase,” he said. “It’s not just Greece; the sands are shifting in the global economy under the ECB’s feet.”
The ECB last month forecast euro-region growth to slow to 1.7 percent next year from 1.9 percent in 2011. The inflation rate may fall below its 2 percent ceiling in 2012, averaging 1.7 percent, the central bank estimated. In June, consumer prices rose 2.7 percent from a year earlier.
Surging energy and commodity costs prompted the ECB to raise interest rates in April. Trichet as recently as June 30 called for “strong vigilance” on price pressures, a term used in the past to signal an imminent rate increase.
Trichet, who retires at the end of October, today may also face questions over the ECB’s collateral policy. Banks can currently obtain as much money as they need for up to three months against eligible assets including government bonds. ECB policy makers have said they may no longer accept Greek debt as collateral if the country defaults.
It’s a “game of poker,” said Christian Schulz, an economist at Joh. Berenberg Gossler & Co in London, who used to work at the ECB. “The ECB knows it’s the last line of defense in the euro zone but it really is up to the front lines, in other words the governments, to do their job.”