The European Central Bank is expected to signal on Thursday that it will raise interest rates in July, underlining its determination to fight inflation as most of Europe enjoys strong growth despite the debt troubles afflicting Greece, Ireland and Portugal.
The debt crisis and worries of a global slowdown may ultimately restrain how far the ECB can raise its key rate going into next year. But for now, the eurozone's chief monetary authority is worried that steep oil and food prices will build up inflation expectations and is seen hiking rates at least twice by year-end from the current 1.25 percent.
The ECB raised rates in April for the first time in three years "to send a strong credibility message to the market and firmly anchor inflation expectations," said Marco Valli, chief eurozone economist at UniCredit Research. "Any backpedaling in the absence of financial market disruption would create ... unwelcome volatility."
While economists predict no rate change at the meeting of the bank's 23-member governing council in Frankfurt, they say President Jean-Claude Trichet will likely let drop the key phrase -- that the bank is exercising "strong vigilance" on prices.
That is the bank's code phrase for an increase at the next month's meeting. Higher rates are a central bank's chief tool to restrain inflation.
A July rate hike of a quarter point would follow up on April's quarter point increase and could set the bank up for steady increases each quarter into next year to keep inflation from remaining high.
Inflation ran at 2.7 percent in May, down from 2.8 percent but above the bank's goal of just under 2 percent for the sixth straight month.
How far the bank will go after July is less clear, however. With Greece struggling to avoid bankruptcy and many European banks in shaky condition, the ECB will be aware of the damage higher rates can inflict on heavily indebted countries still stuck in recessions. Portugal and Ireland, like Greece, have taken bailout loans from the EU and the International Monetary Fund and will find higher rates an added burden on hard-pressed consumers.
Trichet's remarks at his news conference after the meeting will be parsed for his views on the crisis and a possible voluntary swap by banks of Greek debt that is soon to mature for longer-dated bonds. Such a measure is intended to avoid Greece defaulting on or restructuring its debt in a way that disadvantages its creditors.
Still, the countries hit by the debt crisis are only a small fraction of the eurozone economy, a bloc of 17 countries with 331 million people that is enjoying good economic growth on the whole.
The eurozone grew a robust 0.8 percent during the first quarter, led by Germany, the region's biggest economy. There, falling unemployment and strong exports of cars and machinery argue for higher rates.
Developments outside Europe could also hinder ECB rate hikes. Because the United States and Britain are keeping their rates at record lows, more ECB rate increases will tend to boost the euro further, hurting exports. The Fed shows no inclination to raise rates from 0-0.25 percent, and no increase is expected Thursday from the Bank of England, whose key rate is at 0.5 percent, another historic low.
While they agree on a July rate hike, analysts disagree about how many more are coming. Howard Archer of IHS Global Insight sees the base rate at 2.5 percent by the end of next year.
Jonathan Loynes of Capital Economics thinks the bank will do one more, to 1.5 percent in July, and then pause.
The conflicting forces the ECB has to consider are underlined by the bank's continuing supply of unlimited credit to eurozone banks, some of which are unable to borrow normally from other banks. Most analysts expect this practice to continue, with three-month credit remaining available in unlimited amounts, as governments seek to prop up Greece and push banks to thicken their capital buffers in coming months.
AP
