ECB keeps key rate at six-year high

The European Central Bank kept interest rates at a six-year high yesterday to fight inflation even as the euro-region economy cools.

ECB policymakers meeting in Frankfurt left the benchmark lending rate at 4 percent.

The ECB is concerned that unions will push through demands for higher wages and companies will lift prices to compensate for record energy and food costs, which have fueled the fastest inflation in 16 years.

Price increases are also draining consumers' purchasing power, weighing on an economy already struggling with a credit squeeze and the stronger euro.

"The ECB is trapped," said Joerg Kraemer, chief economist at Commerzbank AG in Frankfurt. "We have the problem of persistently high inflation rates, while growth is weakening. I expect them to keep rates on hold for a very long time."

Separately, the Bank of England kept its key rate at 5 percent.

Central banks in Indonesia and the Philippines increased rates yesterday, joining policymakers across Asia who are raising borrowing costs to tackle runaway inflation.

Weber's call

Inflation in the 15-nation euro region accelerated to 3.6 percent in May, matching March's 16-year high. The ECB, celebrating its 10th anniversary this week, aims to keep the rate just below 2 percent, something it has failed to do every year since 1999.

ECB council member Axel Weber has called for the bank to consider raising interest rates.

With crude oil prices rising 16 percent since its last forecasts were published in March, the ECB may "significantly" revise up its inflation outlook, said Holger Schmieding, chief European economist at Bank of America Corp in London.

He estimates the 2008 forecast will be raised to 3.3 percent from 2.9 percent and the 2009 prediction to 2.3 percent from 2.1 percent.

There's a chance "the ECB could rattle markets by switching from a neutral outlook to a clear tightening bias", Schmieding said. The ECB has said Europe's economic fundamentals are sound and stressed the need to keep inflation expectations in line with its 2 percent price-stability goal.

In a report last week, the bank said inflation expectations appear to be "trending up". Expectations, as measured by French inflation-indexed bonds, have risen above 2.4 percent from 2.1 percent two months ago.

"If expectations are dislodged, the ECB will react and hike rates," said Stephane Deo, chief European economist at UBS AG in London.

The bank will "certainly act against persistent inflation even if growth is at risk".

Eonia swap contracts, a widely used market gauge of interest-rate expectations, show investors have fully priced in a quarter-point rate increase from the ECB by the end of the year.

Europe's economy expanded more than economists forecast in the first quarter, prompting the International Monetary Fund to raise its euro-region growth forecast for this year to 1.75 percent from 1.4 percent. That's still less than last year's 2.6 percent.

'Consumer recession'

There are signs growth is slowing. Manufacturing orders in Germany, the region's largest economy, unexpectedly declined for a fifth month in April, the government said yesterday.

European retail sales suffered the biggest annual drop in April since records began, and executive and consumer confidence remained at the lowest in almost three years in May.

"Inflation is painfully high and the negative effect on purchasing power is squeezing the life out of the domestic economy," said Ken Wattret, an economist at BNP Paribas SA in London.

"It now looks increasingly like a consumer recession is unfolding."

The US Federal Reserve has reduced its main lending rate seven times since mid-September, to 2 percent from 5.25 percent, after the collapse of the subprime mortgage market drove the world's largest economy to the brink of a recession.

The US housing slump has caused at least $386 billion in credit losses and writedowns at the world's biggest banks and pushed up credit costs globally.

Agencies

(China Daily 06/06/2008 page17)