The European Central Bank kept its main interest rate steady at 1.25 percent as ECB governors met here after Portugal became the third eurozone country to accept a bailout. Rising inflation will probably lead to a rate increase in June or July, but the ECB stuck to the level reached in April as 78 billion euros ($116 billion) in loans for Lisbon underscored the eurozone’s debt woes.
Economists are divided on how high the benchmark rate could climb this year, but put the ceiling at 1.75 to 2.0 percent. In Portugal, International Monetary Fund and European Union negotiators unveiled terms of the eurozone’s latest financial rescue package. They include reform of Portuguese laws protecting the labour market and cuts in the amount and duration of unemployment benefit, but also a reduction of charges on employment. In throwing a lifeline to the last of three seriously threatened peripheral eurozone countries, the others being Greece and Ireland, EU officials seek to keep the crisis from pulling down a much bigger member, Spain.
The ECB governing council, after one of its rare meetings outside the bank’s headquarters in Frankfurt, is expected to comment on the agreement and also try to keep markets from targeting Madrid with steeper rates to finance its debt. But “having left the benchmark interest rate on hold at 1.25 percent, as expected, the key question now is whether the ECB will provide any clearer signals of the timing of the next interest rate hike at the press conference” that follows the rate decision, Capital Economics economist Ben May said.
Analysts are waiting to hear if ECB president Jean-Claude Trichet says the council will remain “vigilant” with respect to inflation pressures, a code word that a rate hike is in the pipeline. “In ECB parlance ‘vigilant’ should be translated by ‘we plan to hike at the next meeting’,” UBS economic research head Stephane Deo said, before adding that he thought Trichet would say Thursday that the bank remained “alert.” That could be upgraded to vigilant next month to signal a rate rise in July. Analysts at the Italian bank UniCredit wrote in a research note that “we expect the ECB to keep the ‘very close monitoring’ wording, which would signal no rate hike until July.”
The ECB is striving to pull monetary policy for the 17-nation bloc back towards normal by slowly returning interest rates to pre-crisis levels and unwinding exceptional measures taken during the financial meltdown. Some commercial banks are now dependent on unlimited and cheap ECB funds to stay afloat and another step towards normal conditions would be to strengthen the banking sector, which is facing a second round of stress tests. Inflation fuelled in large part by higher oil prices has hit 2.8 percent according to the latest EU estimate, forcing the ECB to raise rates even though that drives the value of the euro higher, now above 1.48 dollars, and makes life harder for eurozone exporters.
It also puts pressure on eurozone governments that are struggling to stay solvent. The Bank of England kept its main rate at 0.50 percent on Thursday, while the US Federal Reserve’s Fed funds rate is essentially zero, so higher eurozone rates spur demand for the euro as investors seek higher returns. Recent eurozone data suggests the economy might be headed for a slowdown, which could give the central bank a reason to hold off on its next increase while it deals with the debt crisis. The question of who will succeed Trichet when he steps down in October appears to have been settled however, with most observers looking to Italian central bank governor Mario Draghi.
