ECB Hikes Rates; Bank of England Holds Steady

ECB's increase was expected; England keeps rate at record low

The European Central Bank (ECB) on Thursday raised interest rates by 0.25% to 1.25%, which had been expected for some time. It took the action in an effort to fight inflation throughout the 17-country euro zone, after hinting for some time that it would do so at its next meeting. It was the first rate increase since July of 2008.

Earlier, the Bank of England (BOE) maintained interest rates at a record-low 0.5%, despite inflation running at 4.4%, which is more than double the target amount. The concern by the BOE was that raising rates would snuff out any potential recovery.

Reuters reported that the ECB also increased its deposit rate by 25 basis points, and its marginal lending rate as well; the former now stands at 0.50% and the latter at 2.0%.

With the rate hike following on the heels of a request by Portugal for a bailout at last, observers were monitoring the ECB news conference and the remarks of its president, Jean-Claude Trichet, for any signs that there might be an additional rate hike later in the year. Although peripheral nations in the euro zone will not welcome the ECB's action, now that Portugal has accepted the need for a rescue the central bank may act more strongly to address the issue of inflation.

Concerns are strong that rising oil prices because of unrest in the Middle East/North Africa (MENA) region will drive higher rates of inflation and require more action. Markets are already pricing in two more increases of a quarter point each in interest rates, in expectation of just such a move. Inflation in the euro zone has already hit 2.6%, exceeding the ECB's target of 2.0%.

Observers will also be watching to see whether Trichet gives any indication about an end to the unlimited loans that have been offered by the ECB. They were initiated as an emergency step, but have become so much a part of practice that the ECB is now unable to control market sales because it has injected so much money into banks. Trichet will have to be wary about this, because there is considerable disagreement within the governing council of the ECB over just how to accomplish the creation of a new liquidity facility to assist nations in need of help.

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