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FRANKFURT - The European Central Bank lifted interest rates to a five-year high today and said it would keep a very close eye on price risks, leaving the door open for further rate increases some time next year.
Euro zone interest rates of 3.50 per cent are still low and monetary policy remains accommodative in an economy growing at a solid rate and facing upside inflationary risks, the ECB said in a statement following its sixth rate hike in the past year.
"Looking ahead, acting in a firm and timely manner to ensure price stability in the medium term is warranted," ECB President Jean-Claude Trichet said at a news conference.
"The Governing Council will monitor very closely all developments so that risks to price stability over the medium term do not materialise."
Although these words in the past have been used to alert markets another rate rise is coming in two months time, Trichet dampened speculation for a February rate hike.
"That would be a wrong interpretation," Trichet said in response to reporters' questions. "What would be correct (is) as always we reserve the possibility to act at any time."
European stocks rallied after Trichet played down the prospect of a February rate rise, but Euribor futures slid , implying expectations of a hike by March of around 50 per cent, up from a 30 per cent chance before the announcement.
By saying that rates remain low even after 150 basis points of rate tightening, Trichet left little doubt that further hikes were in store next year.
In a Reuters poll conducted after Trichet's news conference, analysts strengthened rate hike expectations in 2007. Three quarters of economists predicted ECB rates at 3.75 per cent by the end of March, up from 68 per cent last week. A narrow majority now see rates rising to 4 per cent in 2007.
Trichet's rate warning came despite favourable new ECB staff projections that forecast inflation in 2007 at 2 per cent and 1.9 per cent in 2008, down from 2.2 per cent expected for 2006. These levels would mean the ECB achieves its goal of getting inflation to just below 2 per cent for the first time since 1999.
"Those hoping that today could have marked a peak in the ECB's rate normalisation process could be disappointed," said Audrey Childe-Freeman, economist at CIBC in London.
"It seems clear that further rate hikes are in the pipeline but we may have to wait until March to see the next policy action."
ECB rates are now the highest since November 2001. The Danish central bank, as usual, matched the ECB and lifted its discount rate 25 basis points to 3.5 per cent. The Bank of England as expected kept its rate steady at 5 per cent.
Politicians greeted the rate rise with resignation. Italian Prime Minister Romano Prodi said he did not see any inflation dangers, and Portuguese Finance Minister Fernando Teixeira dos Santos said it was not ideal for Portugal but he would not dramatise the situation. Europe's main trade union body repeated its call for a moratorium on further rate rises.
Trichet gave no hint that euro strength would stay the ECB's hand in raising interest rates again. Asked about the impact of the euro's 2.7 per cent surge over the past few weeks, Trichet merely repeated the Group of Seven financial policymakers' statement that sharp currency moves are undesirable.
"Despite the recent rise in the euro the ECB still seems determined to hike interest rates," said Elga Bartsch, European economist at Morgan Stanley.
The currency held broadly stable around US$1.3293 after Trichet sounded no alarm bells over its advance.
Quizzed on what monitoring inflation risks "very closely" meant, Trichet refused to elaborate further. "Our permanent posture is that we are constantly alert," he said. The bank would watch economic data carefully and make its judgement to achieve price stability, he said.
Trichet urged employees not to seek large wage increases on the heels of German trade unions showing increasing discontent over their pay settlements. Trichet called wages an upside risk to the inflation outlook.
On the growth front, however, the ECB was more upbeat. Its new staff forecasts revised GDP growth for 2007 upward slightly to a 2.2 per cent midpoint within a range, from 2.1 per cent expected three months ago.
Trichet warned there would be some quarterly fluctuations due to the German value-added tax increase that takes effect at the start of next year. He continued to predict that the US slowdown would be "smooth"
For 2008, ECB staff projected that growth would remain solid at 2.3 per cent.
- REUTERS