ECB raises borrowing rate despite economic slowdown

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In a widely expected move aimed at keeping inflation in check, the European Central Bank (ECB) yesterday (3 July) raised its central rate to 4.25%, sending euro trading near to its highest level against other currencies.

ECB President Jean-Claude Trichet said the decision to increase the key interest rate by 25 basis points “was taken to prevent broadly based second-round effects” on inflation, which in May hit a record high in the 15-nation eurozone (EURACTIV 17/06/08).

The raise sends the ECB’s central ‘refinancing rate’ to its highest level since 2001. The previous rate rise came in June 2007, before the credit crisis started hitting the US, dampening growth prospects in Europe and raising fears of a worldwide recession.

While Trichet admitted that the ECB’s decision had been taken against a background of “weakening of real GDP growth in mid-2008,” he said the economic fundamentals of the euro area nevertheless remained “sound”.

“Growth in the world economy is expected to remain resilient, benefiting in particular from continued robust growth in emerging economies. This should support euro area external demand,” Trichet said in a statement.

The ECB’s perceived narrow focus on containing inflation has been a subject of repeated criticism from Nicolas Sarkozy, the French President, who assumed the EU’s six-month revolving presidency on 1 July. In his view, the ECB should also keep an eye on maintaining borrowing costs low enough to stimulate investments, exports and economic growth.

European industries are also concerned about the impact of the strong euro on exports. In a press conference yesterday, the European Aerospace and Defence Industries Association (ASD) said it is planning a meeting with the ECB to present it with the facts on how the euro-dollar rate is hurting competitiveness. “Despite efforts to develop new production strategies and encourage greater productivity, each 10 cent devaluation of the US dollar against the euro produces a loss of margin of one billion euros to major companies,” said ASD President Åke Svensson. 

This view was echoed by ETUC, the European Trade Union Confederation, which said the ECB’s decision was “not comprehensible” in face of the current economic slowdown. “Tightening monetary policy […] is inviting recessionary forces to take hold,” ETUC said, adding that the ECB’s decision would “choke” the euro area economy and “do little to address the real causes of inflation” which “is essentially imported from the rest of the world through high oil prices”.

In Germany, the eurozone’s largest economy, Finance Minister Peer Steinbrück, a social democrat from the SPD Party, also criticised the ECB’s anticipated rate rise. In a comment published in the weekly Der Spiegel on 28 June, he expressed fears that higher rates would further dampen economic growth in Germany.

Steinbrück’s unusual remarks were however quickly rectified by Michael Glos, the conservative (CDU) economy minister, who defended the bank’s decision by recalling Europe’s record level of inflation.

Speaking to the Financial Times on Friday (4 July), Steinbrück made a U-turn, saying he had “full respect” for the ECB’s decision. “Worldwide inflation will affect us for a longer time” than financial market turmoil, he said.

According to Eurostat figures published in June, fuel for transport was 14% more expensive in May 2008 than one year before. Prices for milk, eggs and cheese have increased some 14% in the last 14 months.

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