ECB rate rise hint rocks markets

©Reuters

The European Central Bank has jolted financial markets by signalling that interest rates will almost certainly rise in April, taking a markedly more aggressive stance on inflation than the Bank of England and US Federal Reserve.

Sending the euro sharply higher, Jean-Claude Trichet, ECB president, on Thursday warned that the euro’s monetary guardian was exercising “strong vigilance” – code for a rate increase just a month away. A hike next month from the record low of 1 per cent, was “not certain, it is possible” he said. Inflation risks were on the “upside”, especially if oil and commodity prices rose further, while monetary policy was “very accommodative”, the ECB president said.

Economists warned that the ECB’s action risked backfiring, pointing out that its last interest rate increase in July 2008 came just months before the collapse of Lehman Brothers.

Mr Trichet indicated that interest rates would increase by only a quarter percentage point, however, and said an April hike would not have “the sense of the start of a series of rises” – although he used similar words at the start of the last tightening cycle in December 2005.

The ECB wanted to act pre-emptively with an interest rate “flu shot” and would see how the economy performed, said Peter Vanden Houte, European economist at ING.

In spite of its hawkish stance on inflation the ECB shelved further steps to unwind the exceptional support for eurozone banks it has provided since September 2008.

In the UK, the Bank of England is also moving closer to interest rate increases to combat inflation. But the US Federal Reserve has seen less of an inflationary threat in rising commodity prices. Ben Bernanke, Fed chairman, this week said that they are most likely to cause “a temporary and relatively modest increase in US consumer price inflation”.

But positive economic data could turn the Fed debate towards an earlier move. Attention will focus on today’s non-farm payrolls report for February, the most important US data release, to see whether it confirms a labour market recovery.

The euro rose 0.5 per cent to $1.3937 against the dollar and 0.83 per cent to £0.8563 against sterling. German two-year bond yields jumped a quarter of a percentage point to 1.77 per cent.

The news also drove a wedge between stronger and weaker “peripheral” eurozone countries. Shares in Spain, Italy and Portugal – where a rate rise may push economies into reverse – fell while German and French stocks ended the day higher.

Additional reporting by David Oakley in London