Thursday, March 3, 2011

European Central Bank warns it may raise interest rates

Jean-Claude Trichet, ECB president, shocks analysts with hard line on interest rates that could bankrupt Ireland and Portugal

European interest rate setters piled pressure on the continent's most indebted nations after the European Central Bank warned of a rate increase next month that could send Portugal and Ireland closer to bankruptcy.

Jean-Claude Trichet, the ECB president, said it was possible base rates on the continent could be raised in April to calm inflation, which he said was causing concern and could move further above the central bank's target.

Trichet said the ECB was prepared to act "in a firm and timely manner" to prevent inflation from racing out of control. "Strong vigilance is warranted with a view to containing upside risks to price stability," he said.

His remarks stunned currency traders, who said his previously careful remarks had been ditched in favour of a harder line. The euro strengthened on Trichet's comments to just below $1.40.

However, the prospect of a rise in rates and a stronger currency put the spotlight on countries already paying high interest rates on their debts and would face a jump in costs should base rates go up. Irish political leaders are trying to persuade the EU that the costs of its bailout are punishing and will prevent it from recovering.

Germany's chancellor, Angela Merkel, has rejected attempts by the newly installed Irish prime minister, Enda Kenny, to reopen talks on the bailout package before a summit next week.

The Fine Gael leader, who is negotiating with other parties to form a government, phoned Merkel and European commission boss Jos� Manuel Barroso last weekend to plead Ireland's case, but was told the original deal still held.

Merkel told parliamentary allies in the Bundestag that a deal to cut borrowing costs for Ireland and Greece was unlikely, despite appearing to relax her opposition last year.

Merkel has lost one major regional election this year and faces six other contests, which she believes will also be lost if she caves in to demands for lower bailout costs from peripheral nations.

There is widespread belief inside Germany that Ireland and Greece should suffer the consequences of their profligacy during the boom years by paying higher rates of interest on their debts. Ireland pays an average of 5.8% on its debts while Germany's two-year bond yields remain below 2%.

The summit next week is expected to be acrimonious if Merkel sticks to her guns. Germany is also expected to be the focus of discussions at the summit following its strong economic performance, which many economists blame for the Eurozone's inflation worries. Without Germany's recent consumer spending boom, eurozone inflation would be flat and the ECB would be under little pressure to raise rates.

Spain, Portugal and Italy have seen the cost of financing their debts increase since an EU summit last month that failed to endorse an economic competitiveness plan proposed by Merkel and the French president, Nicolas Sarkozy, as a condition for aid. Belgium, which has failed to agree a new government after elections last spring, and Italy have also suffered higher borrowing costs.

Portugese prime Minister Jose Socrates said last month that the sovereign crisis was the biggest challenge to the European Union and the bloc's prestige depended on defeating it. He said he was willing to push through public spending cuts, but was concerned a refusal to protect indebted countries from attacks by investors, could mean the cuts were in vain.

Harvard University professor Kenneth Rogoff told German finance ministry staff on Thursday that Europe's sovereign debt crisis was far from over, that Greece and Ireland would need to restructure their debts and bailouts may be needed for Spain and Portugal for them to survive.

Rogoff, a former International Monetary Fund chief economist, has become famous among economists for his analysis of financial crises over the last 800 years. He said: "I do think the eventual restructuring of two or three countries ? Greece, Ireland, Portugal ? is inevitable," though it "may be called something else, for face- saving reasons".


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Source: http://www.guardian.co.uk/business/2011/mar/03/ecb-warns-of-interest-rate-rise

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