U.S. News

European Central Bank Hikes Rates, Signals Further Rises


As expected the European Central Bank raised short-term interest rates to 3.5% from 3.25% and ECB President, Jean-Claude Trichet, has signalled that more hikes are on their way.

"Looking ahead, acting in a firm and timely manner to ensure price stability in the medium term is warranted," said Trichet at a news conference immediately after the rate decision. He added "The Governing Council will monitor very closely all developments so that risks to price stability over the medium term do not materialize."

All major European indices are trading up following the statement despite Trichet’s hawkish tone.

"The (interest rate) decision is what has been expected in financial markets," Paul Schmidt, professor of economics at HfB Business School of Finance and Management, told "Power Lunch Europe." "The ECB has pointed out again and again that there are risks for price stability in Europe."

Trichet all but signalled that an increase would come this week after the bank's last meeting in November, saying the Governing Council was using "strong vigilance" in regard to inflation.
Today's move is the sixth hike since December 2005, when the euro-zone's economy started picking up. The recovery has been broadly sustained, with demand for credit still strong in the 12-nation zone that has more than 313 million people and a combined gross domestic product that accounts for 14.8% of the world's GDP.

"The key question is what will the central bank do early next year," Rainer Guntermann, euro-zone economist at Dresdner Kleinwort, told "Today's Business." "A stronger euro currency (means) a pause early next year is much more likely than it was before."
Right now there "is no real danger" of inflation, with the rise in prices, excluding food and energy, very low, Ulrich Leuchtmann of Invesco Asset Management told "Squawk Box. Europe."

But today's rise "gets interest rates into neutral territory, so (the ECB is) open to whatever comes ahead," Leuchtmann said. Another rate hike in the first half of 2007 "will get interest rates exactly to neutral in my estimation," he added.

Euro Strength a Concern

With the euro hovering at 20-month highs, around $1.33, just 3 cents off its all-time high of $1.3667 reached at the end of December 2004, analysts are concerned about what the strength of the common currency could mean for future rate increases through 2007.

As the currency rises, it can help lessen inflation and ease pressure on the central bank to raise interest rates. But it can also hampers European exporters by making their goods more expensive in crucial foreign markets like the United States.
Trichet, who two years ago called the rapid rise of the euro "brutal" and major movements in the exchange rate "not welcome and not appropriate," has this time not tried to talk the euro down.

So far this time, he has warned only about rapid changes in the exchange rate, saying "excess volatility is undesirable for economic growth."

Bank of England Waiting on Data

While the Bank of England's lack of action was expected, the future direction of U.K. rates is uncertain. Economists polled by Reuters indicated a 40% chance of another quarter-point rise to 5.25% in February.

Inflation was running at 2.4% in October, some way above the bank's 2% target, but the Bank is confident price pressures will abate sharply over the coming year as oil prices ease, Reuters reported. The U.K. housing market remains strong, but the government reported a surprise drop in October industrial output on Wednesday.

Consumer spending numbers over the next two weeks will be crucial to judging the health of the U.K. economy, Justin Stewart, strategist at at Seven Investment Management told "Power Lunch Europe." Stewart said spending will likely fall off and he is concerned about overall economic growth.