Interest rates: Europe could see hike in April

Interest rates could be pushed up next month, the head of the European Central Bank says. But he doesn't foresee a big hike in interest rates.

Michael Prbst/AP
Head of European Central Bank Jean-Claude Trichet gestures during a press conference in Frankfurt, Germany, March 3, 2011. He surprised markets by indicating that the bank could raise interest rates in April.

The European Central Bank's chief shocked markets Thursday by saying interest rates could be raised at the next policy meeting in April to fight inflation across the 17-nation eurozone.

Speaking after the bank left its main interest rate at the record low of 1 percent, President Jean-ClaudeTrichet said "strong vigilance" was warranted and that an interest rate increase next month was "possible" though "not certain."

"It is paramount that the rise in inflation does not lead to second-round effects and thereby give rise to broad-based inflationary pressures over the medium term," said Trichet. Second-round effects are wage increases, which threaten to embed high inflation in an economy.

However, Trichet appeared to dismiss the notion of a big rate increase — that is, more than a quarter point — arguing that it was "not appropriate."

Trichet said risks to prices are "on the upside" and that the whole governing council is "prepared to act in a firm and timely manner" to keep inflationary pressures from mounting.

"The continued firm anchoring of inflation expectations is of the essence," Trichet said.

The scale of Trichet's hawkishness came as a big surprise in the markets. The euro shot up around a cent to around $1.3950 while bond prices across the single currency zone fell.

"Markets were expecting big things from the ECB's press conference, and Trichet delivered," said Benjamin Reitzez, an analyst at BMO Capital Markets. "The bank appears eager to prove its inflation-fighting credentials."

In the year to February, higher food and energy costs pushed consumer price inflation in the eurozone up to 2.4 percent — further above the ECB's keenly held mandate of keeping price increases "close to but below" 2 percent.

The ECB also published its staff forecasts, and these confirmed that inflationary pressures have swelled since the last time they were published in December.

Trichet cautioned that the forecasts were made before the latest spike in crude prices due to the tensions in Libya.

"It should be stressed that the projections are based on commodity price futures as of mid-February 2011, and therefore do not take into account the most recent oil price increases," Trichet said. "Moreover, it needs to be emphasised that the projections assume continued moderate domestic wage and price-setting behaviour."

The prediction is now that inflation in the eurozone will be between 2.0 percent and 2.6 percent in 2011 and between 1.0 percent and 2.4 percent in 2012.

Though Trichet was sounding tough on inflation, he said the ECB would continue with its crisis measures to give banks as much liquidity as they require to deal with ongoing liquidity problems.

"The provision of liquidity and the allotment modes will be adjusted as appropriate, taking into account the fact that all the non-standard measures taken during the period of acute financial market tensions are, by construction, temporary in nature," Trichet said. "Accordingly, the governing council will continue to monitor all developments over the period ahead very closely."

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