ECB suggests slower pace of interest rate hikes

By David Mchugh

Associated Press

Published: Thursday, May 5 2011 10:00 a.m. MDT

In this photo made available from the Bank of Finland, showing President Jean-Claude Trichet, front left, of the European Central Bank, faces Governor of the Bank of Finland Erkki Liikanen, right, and Governor of Eesti Pank Andres Lipstok, at the start of the Governing Council meeting of the ECB, in Helsinki, Finland, on Thursday May 5, 2011.

Bank of Finland, Markku Ulander) FINLAND OUT - NO SALES - EDITORIAL USE ONLY, AP Photo

FRANKFURT, Germany — European Central Bank head Jean-Claude Trichet offered struggling Greece, Portugal and Ireland a little bit of relief Thursday by signaling that the bank would not raise interest rates as fast as the markets had been expecting.

Though the bank left its key rate unchanged at 1.25 percent, as expected, at a meeting in Helsinki, Finland, the euro suffered one of its worst days this year after Trichet signaled that another rate hike next month was not likely.

He said the bank would "monitor very closely" all risks to inflation, language that economists say indicates no rate increase at next month's meeting. Though an increase in July is still expected, the pause gives some breathing space to the eurozone's three bailout victims, particularly to Greece as it tries to dispel fears that it will renege on its debt deals.

Investors had been expecting Trichet to say the ECB was practicing "strong vigilance" over inflation, which in the past has been interpreted as a rate increase the following month. Those predictions pushed the euro towards 18-month dollar highs as higher rates can boost a currency by attracting investors.

Following Trichet's remarks, the euro slumped over 2 cents from around $1.48 to a low of $1.4585.

"The euro was hammered after Trichet failed to signal a rate hike next month," said Benjamin Reitzes, a foreign exchange strategist at BMO Capital Markets.

Though expectations of a June rate rise have been more or less dashed, the markets still expect several more quarter point increases this year following April's first increase in nearly three years.

Trichet made it clear the bank is ready to move rates higher to quell inflation that is running above the bank's goal of just under 2 percent, even though higher borrowing costs will heap more pressure on the eurozone's three bailout economies.

However, the slower pace, as indicated Thursday, suggests the bank sees slightly more risk to Europe's recovery. Trichet said the risks to growth "remain broadly balanced in an atmosphere of considerable uncertainty."

Higher rates are the bank's chief weapon against inflation, which ran at 2.8 percent in the year to March. But they also put more pressure on hard-pressed businesses and consumers with adjustable mortgages and other forms of debt in the three bailed-out countries.

Their governments' debt loads are so big, many economists expect one or more to fail to pay everything they owe, through a restructuring that would give bond holders — voluntarily or involuntarily — new bonds paying less than the full value of the current ones.

As the ECB was meeting, Portugal, the EU and the International Monetary Fund on Thursday were thrashing out the terms of a €78 billion in rescue loans. Greece and Ireland have already been bailed out, but are still struggling with slow growth, deficits and huge debts.

Asked if the pace of increases was slowing to help the indebted countries, Trichet said, "Absolutely not. We are responsible for price stability in the eurozone as a whole. We will continue to deliver price stability."

He brushed aside questions about debt restructuring and said Greece would stick to its bailout agreement of spending cuts and reforms in return for emergency loans. "We have a plan. We apply the plan. It's (restructuring) not part of the plan."

Despite Trichet's dismissal, more and more economists are discussing possible restructuring scenarios for Greece. They note that waiting may make a debt restructuring even harder. Right now, most debt is owed to bond holders. But as the rescue loans are paid out, the EU and the IMF increasingly become the countries' main creditors — making a writedown politically trickier.

One scenario is a voluntary restructuring, in which the governments repay bondholders at a later date than initially planned with relatively little loss to the original value of the bonds.

At least one analyst said the debt crisis was giving the ECB a reason to slow down.

"We believe that the ECB will be wary about raising interest rates aggressively due to the growth headwinds facing the eurozone and the problems higher interest rates will cause for Greece, Ireland, Portugal and Spain," said Howard Archer of IHS Global Insight.

Unlike the three bailed-out countries, Spain is still able to borrow normally but faces dismally high unemployment at 21.3 percent.

The Bank of England also held off Thursday, leaving its key policy rate at 0.5 percent despite concerns about inflation running at 4 percent in March.

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