Economists explain ECB logic in raising rates, but warn of risks to periphery

Following its first increase in several months in April, the European Central Bank’s governing council raised interest rates by a further 25 basis points to 1.5%. European economists say the amount stronger countries in the region contribute to its GDP drove the move, but warn of further damage to Europe’s periphery.

Speaking in Frankfurt, ECB president Jean-Claude Trichet said upward pressure on energy and commodity prices moved the governing council to raise rates once again. He emphasised the decision was made taking into account the impact on the whole region, not just its troubled periphery.

“The relatively high inflation rates seen over the past few months largely reflect higher energy and commodity prices. Looking ahead, inflation rates are likely to stay clearly above 2% over the coming months,” said Trichet.

“Our decision will contribute to keeping inflation expectations in the euro area firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term.

“Such anchoring is a prerequisite for monetary policy to contribute to economic growth in the euro area,” he added.

Schroders’ European economist Azad Zangana said the rate rise will have been perceived as necessary to maintain confidence, due to the prospect of higher inflation in future. In making its decision, the ECB has to concentrate on Europe as a group, hence its focus on the larger economies like France and Germany, he said.

“The ECB is genuinely concerned about price stability in the Eurozone and in this respect it must be borne in mind that it can only target the EMU-wide inflation rate,” said ING senior economist Willem Verhagen.

“Because peripheral nations including Spain only account for 18% of EMU GDP, they have a relatively low weight in the decision in this respect.”

A rate raise back in April sparked fears householders in countries like Greece, Spain and Portugal will suffer because their mortgages are tied to the one-year Euribor rate.

Greater divergence between the better performing economies in Europe and its weak periphery is a concern, said Schroders’ Zangana.

“It’s a gamble on the periphery”, he said. Consumers in those regions are likely to be hit, but the alternative of punishing companies means growth will not take place, he added.

 

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