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Bank of England Raises Rates Unexpectedly; ECB Rates Steady

The Bank of England raised short-term interest rates to 5.25% from 5% Thursday, surprising the market, while the European Central Bank met expectations and kept rates steady at 3.5%

“Money and credit growth is rapid (within the European Union), reflecting low rates and a strengthening economy” said European Central Bank President Jean-Claude Trichet at a press conference following the European rate decision Thursday. He said that rates remained accommodative, but refrained from more hawkish language that would suggest a rate hike in February.

The Bank of England's move takes rates to their highest level in 5-1/2 years. Only one of 50 economists surveyed by Reuters predicted that the Bank of England would hike rates today.

The bank cited rising consumer inflation, which hit 2.7% in November, as a key reason for raising rates.

"It is likely that inflation will rise further above the target in the near term, but then fall back as energy and import price inflation abate," the Bank of England said in a statement. "Relative to the November Inflation report, the risks to inflation now appear more to the upside."

In addition, "output continues to rise at a firm pace" and domestic "demand has grown steadily and credit and broad money growth remain rapid," the BOE said.

"I can only conclude, although it's an assumption, that they have seen in these advance inflation numbers, something quite scary," Shai Hill, head of research at Arbuthnot, told "Power Lunch Europe." Next week's December consumer price inflation rate could be as high as 3%, Hill said.

You can argue that it's never good to surprise the market, but maybe the BOE wants to be seen as heading off inflation, he added.

The markets reacted sharply to the BOE's surprise decision. The British pound rose 1% against the U.S. dollar to $1.953. And in stocks, London's FTSE-100 fell into negative territory after being solidly higher most of the morning.

If there remains a large spread between U.K. and European interest rates, then it's like the pound could rise above the $2 level in the near term, Paul Chertkow, head of global currency research at Bank of Tokyo-Mitsubishi told "Power Lunch Europe."

Looking for "Vigilance'

For ECB watchers, the lack of the "V" word: vigilance, during ECB President Jean-Claude Trichet's speech indicates that he is comfortable keeping rates steady in the near term.

Recently, Trichet has said the central bank will exercise vigilance against inflation in statements that come right before a rate hike.

James Round, vice president at LRP, predicted on "Squawk Box Europe" Trichet's reluctance to raise in the short term: "as far as the interest rates are concerned, I think we'll see one (hike) in March and not in February.”

Once Every Quarter or Done for the Year?

At the start of the latest tightening cycle, the ECB raised rates once every quarter, then increased the pace to once every two months, Dr. Thomas Meissner, head of fixed income markets research, told "Squawk Box Europe."

Now the end of the cycle is approaching, it's likely the ECB is back to raising rates once a quarter, Meissner said, adding that a neutral rate is somewhere around 3.75% to 4%.

The central bank last raised rates in December.

But with falling energy prices, it is possible that rates to could stay at the current level through 2007, Peter Meister, economist at BHF Bank, told "Worldwide Exchange."

"After six rate hikes they are now in wait-and-see mode," Meister said.

Still, Euribor interest rate futures gave about a 95% chance of a quarter-percentage-point rise in February or March, Reuters reported. And all but nine of the 72 economists surveyed expect a hike sometime in the first quarter.

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