European Central Bank Raises Rates on Inflation Fears

As widely expected, the ECB decided to raise its benchmark "refi" refinancing rate to 3.00 percent, the highest level since December 2002, to counter inflationary high oil prices and accelerating economic growth.

Less than an hour earlier, the Bank of England had also tightened its monetary policy, raising its own key rate for the first time in a year by 0.25 percentage points to 4.75 percent.

The ECB's move is the fourth quarter-point rise in euro-zone borrowing costs since December. The guardian of the euro is concerned about the inflationary effects of oil prices and economic growth.

It also increased its other two key rates -- the deposit rate and the marginal lending rate -- by 0.25 percentage point to 2.00 percent and 4.00 percent respectively.

The announcement had been expected and the euro remained stable at about 1.2770 dollars. The British rate increase, by contrast, had caught the foreign exchange market by surprise and sterling rose.

Normally, the ECB council holds its August meeting in the summer holiday period by means of a teleconference. But this year, the 18-strong board was convening in person at the ECB's Eurotower headquarters in Frankfurt, a sure sign that a move in interest rates was on the cards.

The meeting was also attended by EU Monetary Affairs Commissioner Joaquin Almunia.

Worries about inflation

Inflationary risks are rising in the 12-country euro zone, primarily as a result of high oil prices, European Central Bank President Jean-Claude Trichet said on Thursday.

"The risks to the outlook for price developments have augmented," the ECB chief told a news conference after the increase was announced.

The main risks included "further increases in oil prices, a stronger-than-anticipated pass-through of past oil price rises into consumer prices, and additional increases in administered prices and indirect taxes," the Frenchman said.

He added that euro-zone interest rates are likely to be rise still further.

With area-wide growth currently above trend, inflation above target and credit and money supply growth accelerating strongly, the ECB believes higher borrowing costs are necessary to nip inflation the bud.

Area-wide inflation stood at 2.5 percent on a 12-month basis in June, far above the ECB's ceiling of 2.0 percent, fuelled by runaway energy prices.

The bank is concerned that energy price developments may trigger so-called "second-round" effects, with demands for higher wages to compensate for the high price of petrol and heating oil leading to an inflation spiral.

As yet, there is no sign of that happening, but the ECB believes that prevention is better than cure.

About time

Commerzbank chief economist Jörg Krämer said the tightening move on Thursday was "long overdue".

"The euro area economy is growing solidly at 1.8 percent and the money supply has been expanding faster over the past four or five years than the ECB would like. The rate hike is therefore no danger to the economy," Krämer said on Deutsche Welle television DW-TV.

The rate rise marks an acceleration in the tightening cycle, and Commerzbank's Krämer said he believed the "refi" rate could stand at 3.50 percent by the end of the year.

"I assume there will be two follow-up moves in October and December," he said.

German Economy Minister Michael Glos said Thursday that the European Central Bank's decision to raise its key interest rates again was proof the current economic recovery was gathering strength and momentum.

"In recent months, economic activity in the euro area, and in Germany in particular, has increasingly gained strength," Glos said in a short statement.