With inflation rising, European central banks hold rates steady

By Matt Moore and Jane Wardell
Associated Press
via Yahoo News
Thursday, March 6, 2008

http://news.yahoo.com/s/ap/20080306/ap_on_bi_ge/europe_interest_rates;_y...

FRANKFURT, Germany -- The European Central Bank and Bank of England took similar paths Thursday by leaving their benchmark interest rates unchanged, but analysts expect cuts in the coming months.

The ECB's refinancing rate remained unchanged at 4 percent while the Bank of England left its key rate at 5.25 percent.

Analysts and traders were awaiting ECB president Jean-Claude Trichet's comments on the bank's reasoning. They will look for clues about the effects of the rising euro, record inflation in the 15-nation euro zone and whether fears of a U.S. recession may cause the bank to lower its rates later this year.

Inflation in the countries that use the euro has been at a record of 3.2 percent since the start of the year.

In London, the Bank of England's decision was expected by most economists and followed a cut last month in an attempt to shore up Britain's slowing economy. Economists expect further cuts in the coming months.

However, the bank is also responsible for keeping inflation in check and economists said that soaring food costs and energy prices were likely behind this month's decision.

"Current elevated inflation risks meant that it was too soon for the bank to be comfortable about cutting interest rates again despite serious concerns about the growth outlook," said Global Insight Chief U.K. economist Howard Archer.

Inflation is currently at 2.2 percent, already above the British government's 2 percent target, and a rate cut to boost economic growth can also wind up increasing inflation.

Most economists expect the Bank of England to hold off until May before easing rates further, although an April move is not ruled out if there are signs of a more serious slowdown.

Ian McCafferty, the chief economic adviser at the Confederation of British Industry, Britain's leading employers' organization, said that holding rates showed the bank was determined not to compromise on inflation, but added that another cut would be needed "sooner rather than later."

"The MPC is well aware of the intensifying short-term inflationary pressure and needs to balance this against the weakening of the economy we are experiencing," he said.

The ECB is in a similar predicament, with record inflation and the rising euro, which hit a new high of $1.5347 on Thursday. Most analysts believe the bank will lower the rate to between 3.5 percent and 3.75 percent by the second quarter of this year, provided Trichet is not too worried by the back-to-back inflation of 3.2 percent in January and February of this year.

"The ECB is edging only very gradually toward a possible rate cut," said Holger Schmieding and Gilles Moec, economists with Bank of America in London in a note to investors. "Following the clear shift from a tightening bias to a neutral stance in February, we do not look for a major further change in the ECB statement this time."

But while the bank will hold steady this month, they expect to see as many as two cuts by the end of the year, bringing the rate to 3.5 percent. That's in contrast to the U.S. Federal Reserve, which has chopped its own rate several times to 3 percent. The Bank of England has cut its key rate twice in three months.

On Tuesday, the Bank of Canada cut its key interest rate by half a percentage point to 3.5 percent on Tuesday and indicated further cuts would be needed as a response to a U.S. economy that will likely experience a deeper and more prolonged slowdown than previously projected.

Meanwhile, Australia's central bank raised its key interest rate to 7.25 percent the same day, its highest level in 12 years, to combat inflation.

For Trichet, concerns about inflation are more important than fears about a U.S. recession or even a rising euro.

Fighting inflation is Trichet's key role as president of the bank and he has stressed he will not deviate from that. That is a notable contrast to the Fed, which has a broader mandate to not only fight inflation but preserve economic growth.

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