ECB hikes rates, signals more to come

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PAUL CARREL
FRANKFURT— Reuters
Published Thursday, Jul. 07, 2011 7:57AM EDT
Last updated Thursday, Jul. 07, 2011 9:22AM EDT

The European Central Bank raised interest rates for the second time this year on Thursday and signalled further policy tightening to come to tackle inflation despite the euro zone’s intensifying debt crisis.

But it offered help to hard-pressed Portugal after ratings agency Moody’s downgraded its debt to junk status this week, committing to keep providing it with liquidity.

“We will continue to monitor very closely all developments with respect to upside risks to price stability,” Mr. Trichet told a news conference after the bank raised interest rates by 25 basis points to 1.5 per cent .

Economists said before the news conference that use of that phrase would signal a further rate rise in 2011, likely to be in the last three months of the year.

Euro zone inflation held at 2.7 per cent in June, well above the ECB’s target of just under 2 per cent. Mr. Trichet said monetary policy remained accommodative even after Thursday’s increase.

The rise in the ECB’s benchmark interest rate to 1.5 per cent was widely expected after the bank’s recent reiterations that it was in “strong vigilance” mode – code traditionally used to signal a hike.

“No surprise at all,” Berenberg economist Holger Schmieding said of Thursday’s quarter-point rise.

The ECB raised its subsidiary overnight deposit and borrowing rates in unison, opting not to re-widen its so-called rate ‘corridor’ this time around.

Recent euro zone data has generally disappointed . The latest industrial orders rose less than expected, while growth in the bloc’s dominant service sector has also slowed sharply.

A Reuters poll found economists have softened their rate hike view as the euro zone debt crisis has escalated over the last month.

The ECB’s key rate is expected to rise just once more this year, to 1.75 per cent, with only two quarter-point increases forecast to follow for all of next year.

In contrast, the Bank of England kept rates on hold on Thursday .

The downgrading of recently bailed-out Portugal’s credit rating to junk rattled financial markets on Wednesday and cast new doubt on European efforts to rescue distressed euro zone states without debt restructuring.

The ECB has pledged to keep liquidity flowing to euro zone banks that need it, and Mr. Trichet said Portuguese debt would be accepted by the ECB as collateral for now, come what may.

“We have decided to suspend the application of the minimum credit rating threshold ... for the purpose of Eurosystem credit operations in the case of marketable debt instruments issued or guaranteed by the Portuguese government,” he said.

“This suspension will be maintained until further notice.”

The ECB has proved a major stumbling block in agreeing a second rescue plan for Greece as it has threatened to refuse restructured Greek bonds as collateral in its lending operations in the event of a default or a “restricted default”, which ratings agencies are threatening to impose.

“We say no to selective default,” Mr. Trichet said.

Refusing to accept Greek bonds as collateral would deprive Greek banks of the funds on which they rely, crippling the Greek economy and risking contagion to other euro zone economies. Most economists expect the ECB to baulk at that and keep banks afloat somehow.