ECB, Bank of England Raise Rates to Temper Inflation

BY

ECB, Bank of England Raise Rates to Temper Inflation Aug. 3 (Bloomberg) -- The central banks of the euro region and the U.K. raised interest rates to restrain inflation after economic growth accelerated. Stocks and bonds fell as investors bet borrowing costs are headed higher.

The ECB lifted its key rate a quarter point to 3 percent, as predicted by every economist surveyed by Bloomberg News. The Bank of England unexpectedly pushed up its main rate by the same margin to 4.75 percent, its first increase in two years, a move forecast by just eight of 46 economists.

``We're starting to see some of the central banks move into restrictive mode,'' said James Nixon, an economist at Societe Generale SA in London and a former forecaster at the ECB.

Inflation risks are mounting throughout Europe as near- record oil costs drive up consumer prices and growth quickens. Investors expect both central banks to keep raising the cost of credit, futures trading shows.

U.K. stocks and government bonds slid and the pound rose after the Bank of England announced its decision in London. The drop in gilts pushed two-year yields to a 17-month high, while the benchmark FTSE 100 Index dropped the most in three weeks.

Growth `On Track'

The announcement in Frankfurt by the ECB's 18-member governing council came 45 minutes after the U.K. decision, sending equities and bonds down in the dozen countries sharing the euro. Yields on two-year German bond yields climbed to their highest in a week.

``The economic recovery is on track, excess liquidity is building up and real short-term interest rates are still close to historical lows,'' said Thorsten Polleit, Frankfurt-based chief German economist at Barclays Capital. ``They will make sure that expectations for rate increases remain intact.''

Inflation stayed above the ECB's limit in each of the past 18 months and money-supply growth, which the bank uses to gauge future price risks, is close to a three-year high. At the same time, oil prices are near the record $78.40 they reached on July 14 and the economy is headed for its strongest expansion in six years.

While the biggest part of the European economy, non- manufacturing companies, expended in July by less than expected, it slowed from the fastest in six years in June. A Royal Bank of Scotland Group Plc index based on a survey of 2,000 purchasing managers in the euro-area fell to 57.9 from 60.7.

Inflation `Above Target'

Growth in the U.K., Europe's second-biggest economy, reached the fastest pace in two years last quarter and inflation in June remained above the bank's 2 percent target for a second month. Advocates of the Bank of England leaving rates unchanged had cited increased unemployment and signs companies have kept a lid on wages to control costs.

``The pace of economic activity has quickened in the past few months,'' the Bank of England's seven member policy-making panel, headed by Mervyn King, said in a statement. Inflation is ``likely to remain above target for some while,'' it said.

ECB President Jean-Claude Trichet will hold a press conference at 2:30 p.m. in Frankfurt.

Investors anticipate more rate increases in both the U.K. and in the dozen nations that share the euro.

The yield on the three-month European futures contract for December rose 1 basis point to 3.58 percent. The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 15 basis points more than the ECB's key rate since the currency's debut in 1999.

Rate Futures

The rate on the U.K. interest-rate futures contract maturing in December jumped 0.14 percentage point to 5.13 percent. The contract settles to the three-month London inter- bank offered rate for the pound, which has averaged about 15 basis points more than the central bank's target for the past decade.

Interest rates are climbing around the world with 15 central banks raising them last month. The U.S. Federal Reserve on June 29 increased its benchmark rate for a 17th time to 5.25 percent from 5 percent. The Bank of Japan on July 14 ended its near-zero rate policy and Australia's central bank yesterday raised its rate to a 5 1/2-year high of 6 percent.

Fed Chairman Ben S. Bernanke has begun signaling he may halt the Fed's two-year campaign even as inflation accelerates, noting July 19 that he's wary of lifting borrowing costs too high.

A slowing U.S. economy may also combine with climbing interest rates, rising taxes in Germany and Italy and higher fuel bills to temper the European expansion later in the year. Morgan Stanley Chief European Economist Eric Chaney last week said recession was possible in the euro-area next year.

[ Last edited by BY on 2006-8-3 at 08:52 PM ]