ECB Unexpectedly Raises Benchmark Rate by Half Point (Update1)
By Hellmuth Tromm
Frankfurt, June 8 (Bloomberg) -- The European Central Bank raised interest rates
by half a percentage point, more than analysts had expected, in an attempt to
stop rebounding economic growth and the euro's decline from spurring inflation.
The euro and bonds rose, and stocks fell, after the central bank increased its
benchmark refinancing rate, the amount charged on two-week loans to
commercial banks, to 4.25. The ECB's fifth increase in rates in seven months
will boost borrowing costs in a region that spans from Finland to Portugal, and
includes 290 million people.
In another surprise move that could further raise the cost of credit, the ECB said
it will switch to a variable refinancing rate starting on June 28. ECB officials have
said they're concerned that faster economic growth and the euro's slide during
most of the last year, which boosted the cost of imported goods, will prompt
companies to raise prices.
``With economic growth accelerating there was certainly a case to be made for
raising rates,'' Sarah Luetgert, an economist at HSBC Trinkaus Research in
Dusseldorf.
ECB President Wim Duisenberg will hold a press conference at 2:30 p.m. local
time to explain reasons for the move. Thirty of 36 analysts surveyed by
Bloomberg News predicted a quarter-point increase in rates. One predicted a
half-point increase.
Growth in the amount of money in circulation expanded at a record pace in April,
as individuals and companies increased loans, adding to inflation concerns.
In the latest evidence of a rebound in the euro region's economies, Germany
today reported that industrial production rose 1.5 percent in April from March,
almost twice analysts' predictions. Another German government report today
showed the number of unemployed people in Europe's biggest economy fell in
May for a seventh month out of the last eight, leaving the jobless rate at a
four-and-a-half year low of 9.6 percent.
Switch to Variable Rate
The ECB today also raised its top lending rate by a half point to 5.25 percent,
and the lowest rate by the same amount, to 3.25 percent.
The central bank lends most of its money at its weekly refinancing operations.
The switch to a variable interest rate, starting at 4.25 percent, means
commercial banks that offer to pay the highest rate will be awarded the central
bank's loans. Such a bidding process is likely to drive borrowing costs higher.
That may help to keep the region's 1.9 percent inflation rate below the ECB's 2
percent ceiling.
Borrowing costs ``are set to rise with a switch to a variable rate,'' said Luetgert of
HSBC Trinkaus Research, before the ECB announcement.
Under a variable system, banks may be more cautious in their bids because
they would have to specify not only how much money they want, but also the
rate they are willing to pay. Some commercial banks complained that the
fixed-rate auctions handed an advantage to big banks. Banks tended to overbid
to make sure they got the money they need. Bigger banks could more easily
adjust if they get more money than they wanted.
Overbidding
At this week's auction, banks bid for 8.49 trillion euros ($8.14 trillion) in cash.
The ECB only lent 75 billion euros, or less than 1 percent of that amount, which
created a separate problem: the ECB struggled to gauge the level of demand for
money from commercial banks.
ECB policy-makers had indicated that another increase in borrowing costs was
coming.
The central bank will be ``vigilant to ensure that growth is sustainable and
non-inflationary,'' said Jean-Claude Trichet, head of the Bank of France and a
member of the ECB's rate-setting panel. Otmar Issing, the ECB's chief
economist, said the weak euro ``holds the danger of imported inflation.''
The euro zone's economy is expected to grow 3.5 percent this year, the fastest
pace in a decade, according to the Organization for Economic Cooperation and
Development.
Euro's Weakness
The revival is partly the result of the euro's 18 percent drop against the dollar
since its introduction at the start of last year, which makes the region's goods
cheaper abroad and has helped exporters such as Germany's Volkswagen AG,
Europe's biggest carmaker, and specialty chemicals maker Degussa-Huels AG.
The currency has gained about 8.7 percent in the past three weeks, buoyed by
expectations for higher interest rates and by signs that the pace of economic
growth in Europe may be catching up with the U.S. The euro rose 0.6 percent
after the ECB announcement, to 97.71 U.S. cents. The yield on Germany's
10-year benchmark bond fell 3 basis points to 5.08 percent.
Further gains in the euro and higher interest rates could begin to erode the
competitive advantage that has benefited euro- zone companies. A 10 percent
rise in the euro's value, on an annual basis, shaves about half a percentage point
from the euro area's economic growth, analysts estimate.
The ECB's rate increases have already raised the cost of borrowing for
companies. Yields on two-year German government bonds have climbed about
90 basis points to 4.80 percent since Nov. 4, when the ECB began raising rates.
Many corporate bond yields are based on government debt yields.
Inflation Rate
The inflation rate in the euro region, at 1.9 percent in April, is just below the
central bank's 2 percent limit for the region. Many analysts predict May inflation
figures will show an acceleration after the price of oil rose 17 percent in the
month.
The amount of money in the euro economy is expanding at a faster pace,
leading to concern among ECB officials that too much money chasing too few
goods will fuel inflation. M3 money supply grew at a 6.5 percent annual rate in
April, the fastest since the euro's debut and above the bank's 4.5 percent growth
target.
``The latest money supply figures are stubbornly high,'' said Bernard Walschots,
an economist at Rabobank Nederland.
Some analysts expected the ECB would raise rates today because Duisenberg
will be able to explain the move at the press conference. Six weeks have
elapsed since the last increase, on April 27, and that move and the previous one
came after six-week intervals.
The ECB rate increase narrows the interest-rate gap between the euro zone and
the U.S. and U.K. at a time when growth in those nations may be starting to
slow.
Fed, Bank of England
The U.S. reported an unexpected increase in its unemployment rate, to 4.1
percent from 3.9 percent, on Friday, prompting some analysts to speculate
Federal Reserve officials will refrain from raising rates at their June 28 meeting.
The Fed has already boosted the overnight bank lending rate to 6.5 percent from
4.75 percent in six steps during the past year.
Signs the U.K. economy is slowing prompted the Bank of England to leave its
benchmark interest rate at 6 percent at a meeting yesterday. The U.K. central
bank last increased borrowing costs in February. |
