ECB hikes interest rate to 1.25%

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ECB hikes interest rate to 1.25%
Posted: 07 April 2011 2000 hrs

FRANKFURT : The European Central Bank (ECB) raised its main interest rate on Thursday for the first time since July 2008 just as Portugal became the latest victim of the eurozone's deficit and debt crisis.

The increase in the ECB's benchmark refinancing or "refi" rate to 1.25 per cent also marked the first change in either direction since it was cut to a record low of 1.0 per cent in May 2009.

"Today's move should mark the beginning of a gradual tightening cycle," said UniCredit analyst Tullia Bucco, a trend that could make it harder for countries like Portugal, Ireland and Greece to resolve chronic financial problems.

The latest twist in the eurozone saga came when Lisbon did an abrupt U-turn on Wednesday and said it would seek a financial bailout from the European Union and International Monetary Fund (IMF).

That raised pressure on EU leaders to come up with a durable response to the crisis, with Brussels-based analyst Sony Kapoor from the think tank Re-Define telling AFP: "Procrastination is no longer an option."

Lisbon followed Athens and Dublin in asking for international aid after the Portuguese government was forced to pay sky-high rates to borrow money needed to cover its mounting debt.

Berenberg Bank senior economist Holger Schmieding nonetheless remained upbeat about the general outlook, saying: "Europe will continue to contain its debt crisis so that it does not derail the overall European recovery.

"Europe works in its own messy ways but it is still working so far."

Analysts now wonder whether the rate increase will trigger a series of hikes extending into 2012.

With inflation at 2.6 per cent and climbing, the ECB's governing council has decided to act ahead of its peers the US Federal Reserve, the Bank of England or the Bank of Japan.

In London, the BoE kept its own key rate at a record low of 0.50 per cent on Thursday.

Higher rates could hit southern eurozone countries quickly, for example via home owners who have taken out mortgages with floating interest rates, while a stronger euro will dent their export earnings.

The ECB has taken care however to maintain generous cash loans to commercial banks across the region so money markets function smoothly.

It has also said that all bonds issued or guaranteed by the Irish government would be accepted as collateral for central bank loans, ensuring that struggling Irish banks continue to have access to crucial funding.

Elsewhere on the debt front, the European Commission ruled out restructuring of the Greek debt as EU and IMF officials pored over a new austerity budget in Athens, but financial markets still expect some losses sooner or later.

Against that backdrop and after approving exceptional measures during the financial crisis, the ECB wants to move monetary policy back towards normal and is pressing governments to resolve chronic solvency issues.

- AFP/ms