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News : EU Economy Last Updated: Apr 8, 2011 - 5:35 AM


Trichet says interest rate hike not first of series; Central bank will not accept second round effects
By Michael Hennigan, Founder and Editor of Finfacts
Apr 7, 2011 - 2:58 PM

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European Central Bank President Jean-Claude Trichet at a press conference in Frankfurt, April 07, 2011.

European Central Bank President Jean-Claude Trichet told a press conference in Frankfurt today following the decision of the governing council to hike the benchmark rate by 0.25% to 1.25%, that no decision was made that the rise would mark the first of a series. He stressed that the central bank will not accept second round effects.

The president said it is of "paramount importance" to avoid second-round inflationary effects - - this is where the current spikes in oil and food prices trigger demands for compensatory pay and other cost rises.

"We will continue to monitor very closely all developments with respect to upside risks to price stability," he said and added: "We did not decide that it was the first of a series of interest rate increases. But you know from our own doctrine from the past, you know that we always do what we judge necessary to deliver price stability in the medium term. So I confirm that we will do all that is necessary to deliver price stability."
 

On Ireland, Trichet was asked about advice to the Irish Government on avoiding haircuts on senior bondholders, while he did not answer the question directly but he said it was essential for Ireland to return to normal market funding and that will only happen with a return of confidence.

"We have a number of countries which have to correct their situation and particularly as regards their situation in the fiscal side. But not only the fiscal side, also the economic policies in general. And plans are in place in some countries and they have, in our view, to apply the plan," he said.

A reporter asked about the impact of today's rate rise on struggling Ireland.

He said the governing council sets policy for 331m people and
"it is in the interest of all members and partners of the single market with a single currency that we maintain maximum credibility for the anchoring of inflation expectations."

Today's rate rise will result in an additional €15 per month for every €100,000 of a 20-year term mortgage.

A €300,000 30-year loan on a variable rate of 4.25% would see a monthly rise of €43.57 while in respect of every €100,000 owed on a 30-year tracker mortgage of 1.5% plus the ECB rate, will add €13 to the monthly repayments.

Bank of Ireland and ICS Building Society announced they will increase their fixed rate mortgages by between 0.7% and 1.3%, effective from next week. Tracker mortgages will also rise in line with the ECB increase.

Tracker loans account for about 60% of the Irish residential mortgage market and banks have been losing money at the low rates since 2007.

Introductory Statement

Webcast

Marie Diron – Ernst & Young Eurozone Economic Forecast (EEF) chief economist, comments: "The ECB's decision to raise rates by 25 basis points was no surprise after last month's announcement and recent statements by ECB officials. The ECB is concerned that the commodity-fuelled inflation rates spread to a wider range of goods and services and eventually to wages. The rate increase is probably also aimed at preserving the ECB's credibility as a central bank focused on keeping inflation low. We think that tightening monetary policy already is a mistake.

Ireland

For Ireland, higher rates will only prolong the crisis of the housing and construction sectors. We think that the risk to our forecast of a moderate further fall in house prices this year are on the downside.
In our Spring EEF forecast for Ireland, shows that, at 15%, the country’s full year 2011 unemployment forecast levels is 50% greater than the Eurozone average. The impact of this significantly weakened labour market will continue to have a drag effect on overall economic growth with EEF predicting a decline in GDP by 2.3% in 2011 – almost three times greater than the 2010 decline (-0.8%).

Households in particular are taking a major hit with rising unemployment, downward wage pressures and austerity measures damaging disposable incomes. Today’s announcement will only add to this pressure.

Wider Eurozone impact

True, for some countries and in particular for Germany, a normalisation of monetary policy is warranted. But as Mr Stark reminded us recently, the ECB should not set monetary policy for a few specific countries. Its task is to look at the Eurozone as a whole. And for the Eurozone, risks of inflation becoming entrenched are very low, if significant at all.

With unemployment rates in double digits in many countries and expected to stay high for some time, it is difficult to see how employees would be able to claim higher wage increases as a compensation for inflation.

EEF, and the ECB itself in its March forecast, expect inflation to come back down next year once the commodity and VAT effects disappear. Instead, higher inflation will compress real wages and thereby consumption. And a long list of downward risks loom on the Eurozone, from an escalation of tensions in the Middle East and North Africa, to long-lasting major disruptions in Japan, to a more negative impact of fiscal restructuring in the Eurozone than currently envisaged. And the risk of a full-blown Eurozone sovereign debt crisis still prevails.

The reforms agreed upon at the end of March offer no solution to this crisis. Instead, negative news keeps coming from Portugal, Greece and Ireland, unsettling investors' nerves even more.

Tighter monetary policy will only add to the burden of reeling peripheral countries and increase the risk of a much worse debt crisis. Portugal asking for a bailout from the EU and IMF illustrates that this crisis is far from over. We hope that this rate hike is not the start of a series of rate increases that would seriously endanger the fragile recovery."

Reacting to the ECB's decision to raise its interest rate to 1.25%, business the group, IBEC, said that while an additional rate increase was likely this year, monetary policy in the second half of the year and into 2012 would depend on trends in commodity prices and the stability of the euro and global economic recovery.

Commenting on the CSO figures, IBEC senior economist Reetta Suonperä said:
"Inflation accelerated to 3% in March. Crucially, the EU harmonised index, which excludes mortgage interest, showed that core price pressures in the Irish economy remain fairly muted. Inflation on this measure was 1.2% in the year.

"Increased inflation will eat into consumers' disposable incomes, weakening domestic demand this year. However, the current spike may prove relatively short lived, as underlying inflation pressures in Ireland, and indeed the eurozone, remain muted."

Commenting on the ECB's interest rate decision, Ms Suonperä said: "The increase should not be seen as the first step in a long series of rate hikes. Although headline inflation is above the ECB's 2% target, core inflation remains muted and there have been few signs of the so-called second-round effects, where higher oil prices feed into wage demands and the general price level.

"The ECB has moved before the Bank of England and the Fed. This more hawkish stance from the ECB will add upward pressures on the euro exchange rate. To counteract the negative impact of the stronger exchange rate on Irish exporters, Government must do more to bring down the cost of doing business. Unfortunately, the rate increase will hit hard pressed householders and adds a further headwind to the outlook for consumer spending this year."

Jim O'Neill, chairman Goldman Sachs Asset Management told CNBC he thought an ECB rate hike was premature. The crisis in Europe was not so much a debt crisis as a crisis of governance and leadership of the European monetary union, he said:

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