European Central Bank Raises Interest Rates

For the second time in three months, the ECB raised its benchmark "refi" refinancing rate by a quarter of a percentage point to 2.5 percent at its regular monthly policy-setting meeting.

The last time euro zone borrowing costs stood at that level was in March 2003.

ECB President Jean-Claude Trichet refused to be drawn on the possible timing of future moves, insisting that the bank was ready to take "whatever steps needed to control inflation.

"We don't already have a plan ex-ante for future rate hikes," Trichet insisted.

Nevertheless, the bank would continue to "monitor closely all developments with respect to risks to price stability" and it was ready to act if needed.

Economic growth expected

Future rate moves would depend on economic data, the Frenchman continued.

"We will decide to move on the basis of facts, figures, data, of our future assessment of the risks to price stability," he said.

The bank noted inflationary risks and upgraded its forecasts for area-wide inflation for both this year and 2007.

While the bank had previously been expecting inflation to slow to 2 percent next year from a current rate of 2.3 percent, it was now expecting an average annual inflation rate of 2.2 percent both in 2006 and 2007.

Economic growth was also expected to pick up more markedly than previously thought, with the ECB penciling in growth of 2.1 percent in 2006 and 2.0 percent in 2007, compared with a previous forecast of 1.9 percent for both this year and next.

Higher interest rates would not put the brakes on growth, Trichet insisted.

"It is a stimulative monetary policy," he said. "There is no doubt in my mind."

Criticism and different expectations

Nevertheless, there was strong criticism of the move.

The head of the Green party in the German parliament, Fritz Kuhn, complained that higher borrowing costs would be "poisonous" for investment and growth and would jeopardize the burgeoning recovery in Germany, the euro zone's biggest economy.

The German banking federation BdB also urged the ECB to be careful in tightening the monetary screws any further.

"It must be taken into consideration that the euro-area economy is growing only moderately and the price risks are limited," said federation chief Manfred Weber.

Analysts and ECB watchers were convinced, however, that the tightening cycle was not over.

"In view of the very favorable economic data, we believe that further small interest rates moves can be expected during the course of the year," said Postbank economist Marco Bargel. "The most likely scenario is for another quarter-point hike in June to 2.75 percent."

But HypoVereinsbank economist Marco Kramer said inflationary pressures should soon start to ease.

And with political pressure on the ECB not to raise rates further, the bank will find it "hard to justify another rate hike," he added. "We think that, at their current level, ECB rates have peaked."