MercoPress. South Atlantic News Agency

ECB raises rate and warns of “upside risks to price stability”

The governing Council of the European Central Bank meeting Thursday in Madrid decided to increase the key interest rates by 25 basis points from 2.5 to 2.75% reflecting the upside risks to price stability over the medium term.

"The further withdrawal of monetary accommodation will thus contribute to ensuring that longer-term inflation expectations in the euro area remain solidly anchored at levels consistent with price stability", said ECB president Jean Claude Trichet who added that in spite of the increase, "key ECB interest rates are still low by historical standards, liquidity is ample and our monetary policy remains accommodative".

There had been some speculation that the ECB would go for a 0.5% rise, but analysts agreed that recent market volatility made it settle for 0.25%. However analysts expect eurozone interest rates to rise to 3.25% by the end of the year. Until December 2005 the ECB had left its rate unchanged at 2% for over two years. In March ECB again raised the rate 25 basic points, but last May and April voted to keep rates on hold.

"Conditions are in place for growth in the euro area to remain close to its trend potential rate, despite the impact of the rise in oil prices. Growth in the economies of the euro area's main trading partners remains robust, providing support for euro area exports and strong investment growth is expected to continue", said ECB president Trichet.

According to ECB average annual real GDP growth is forecasted in a range between 1.8% and 2.4% in 2006 and between 1.3% and 2.3% in 2007, with risks to these economic growth projections "broadly balanced over the shorter term, while longer-term downside risks relate mainly to potential further oil price rises, global imbalances and protectionism".

As to the evolution of prices, with annual inflation increasing to 2.5% in May, compared with 2.4% in April and 2.2% in March, "in the months to come and in 2007 inflation rates are likely to remain above 2%, the precise levels depending on future energy price developments".

However even with a moderate evolution of labour costs in the euro area, "indirect effects of past oil price increases are expected to have a significant upward effect on inflation".

Therefore "risks to the outlook for price developments remain on the upside and include further increases in oil prices, a stronger pass-through of past oil price rises into consumer prices than currently anticipated, additional increases in administered prices and indirect taxes, and ? more fundamentally ? stronger than expected wage developments due to second-round effects of past oil price increases".

In the monetary front, president Trichet said that borrowing by households ? especially for house purchase ? and by non-financial corporations has been growing very strongly. "The latest developments confirm that the stimulative impact of the low level of interest rates remains the dominant factor behind the current high trend rate of monetary expansion, which signals inflationary risks over the medium to longer term".

Furthermore the acceleration of monetary and credit growth in this environment of already ample liquidity points to increased upside risks to price stability at longer horizons, warns Trichet. "Monetary developments, therefore, require careful monitoring, in particular in the light of strong dynamics in housing markets".

"Annual inflation rates are projected to remain elevated in 2006 and 2007, with risks to this outlook on the upside. Given the strength of monetary and credit growth and the ample liquidity situation, a cross-check of the outcome of the economic analysis with that of the monetary analysis confirms that upside risks to price stability over the medium term prevail".

Summing up, monetary policy remains "accommodative" and the Governing Council "will continue to monitor closely all developments to ensure that risks to price stability do not materialize".