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Tags: ECB | Rate | Hikes | Greek | greece | europe

ECB to Signal More Rate Hikes Despite Greek Woes

Wednesday, 04 May 2011 01:10 PM EDT

The European Central Bank will underline its determination Thursday to keep raising interest rates as it tries to restrain inflation, even though higher borrowing costs will add to pressure on the debt-laden economies of Greece, Ireland and Portugal.

As the rest of Europe's economy shows continued strength, the ECB is increasingly making it clear that there are limits to what it can do to help the so-called eurozone periphery through its debt crisis.

By pressing ahead with interest rate increases — and halting its purchases of government bonds of troubled countries — the bank is making it clear that it expects the EU's political leaders to step up their efforts.

Greece and Ireland have already taken bailout loans from the European Union and the International Monetary Fund, and Portugal announced late Tuesday it had reached agreement for one. Despite the help, many economists think Greece's debts are ultimately too big to be paid.

The main question at Thursday's ECB meeting in Helsinki, where no rate change is expected, will be how quickly — not if — borrowing rates rise again. The markets will be watching ECB President Jean-Claude Trichet's news conference for signals that the next rate rise will be in June, instead of in July as expected by many analysts.

At April's meeting, the Frankfurt-based bank started what many expect will be a series of increases by raising its key rate to 1.25 percent from a record low of 1 percent.

Higher rates are the bank's chief weapon against inflation, which hit an unexpectedly high 2.8 percent in April, above the bank's goal of just under 2 percent. That is both a result of higher oil and food prices, and also stronger economic growth in most of the 17 countries that use the euro.

However, raising rates can restrain activity and weigh on growth by increasing the cost of borrowing for businesses and consumers. But the ECB's mandate under the Maastricht Treaty that set up the euro remains: fight inflation first.

That is a different approach from the U.S. Federal Reserve, which has made it clear that its rate of 0-0.25 percent isn't going up in the near future, as it is mandated to look at employment levels as well as prices.

One telling sign of a change of approach to the debt crisis is the ECB's halting, at least for now, of its program to buy Greek, Portuguese and Irish bonds. The program helped support bond prices in the secondary market and held down bond yields — the two move in opposite directions.

The ECB, which adamantly opposes a Greek restructuring, last reported making purchases the week ending March 25. It has subsequently held off even as Greek yields spiked to levels that price in a strong likelihood of default.

Marco Valli, chief eurozone economist at UniCredit Research, says the bank is likely noting that Greece's troubles of late have shown fewer signs of dragging down other countries such as Spain and Italy, with European stocks and Spanish and Italian bonds holding up fairly well. Market contagion to those countries would worsen the crisis since they are considered too big to bail out.

"The ECB seems less willing than in the past to take on itself the burden of smoothing the adjustment in peripheral countries," Valli said. "This attitude probably hides growing dissatisfaction on how politicians have been handling the crisis."

Trichet is likely annoyed that the politicians have not permitted Europe's bailout fund to take over some of the bond buying burden from the ECB — as well as some of the risk of holding billions in shaky bonds that might have to be written down if Greece restructures.

The broader picture is that most of Europe's economy is growing moderately and some places — particularly Germany — are doing quite well, with falling unemployment accompanying strong exports and industrial orders. Stronger growth brings with it the prospect of upward pressure on prices, and the bank must choose the rate that fits the European economy best as a whole.

Since Greece, Ireland and Portugal make up only 6.2 percent of eurozone output, they are less important for rate policy than Germany, which alone accounts for 26 percent.

The primary risk for the rest of the eurozone from Greece is not from lagging growth and high unemployment, but from the possibility that banks in other countries suffer losses on peripheral bonds and have to restrict lending to companies.

"Since the April hike it should be clear that the ECB's monetary policy is targeted at the eurozone as a whole," said economist Carsten Brzeski at ING. "The ECB continues to be a believer of one-size-fits-all. This is why we expect further rate hikes this year — but at a moderate pace."

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The European Central Bank will underline its determination Thursday to keep raising interest rates as it tries to restrain inflation, even though higher borrowing costs will add to pressure on the debt-laden economies of Greece, Ireland and Portugal. As the rest of...
Wednesday, 04 May 2011 01:10 PM
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