Depreciating euro succeeds in worrying central bankers

By the time Mr Wim Duisenberg swept in with a platoon of bodyguards to face the media at the European Central Bank's (ECB) headquarters in Frankfurt yesterday, the word was already out that interest rates were set to rise. But there was an unusual air of tension as the white-haired Dutchman explained why the Bank had surprised many analysts by choosing this moment to nudge rates upwards by a quarter of a percentage point.

Mr Duisenberg made a point of stressing all the conventional reasons for increasing the cost of borrowing, such as the growth in money supply and credit to the private sector and recent increases in commodity prices. But he admitted that, for the first time since the euro was launched a year ago, the new currency's poor performance on foreign exchange markets had become a worry for the central bankers.

"The depreciation of the euro which we have witnessed is contributing to increases in import prices," he said, enunciating a truth that has become painfully familiar to Irish consumers and producers in recent months.

Mr Duisenberg has long been signalling that, as the euro zone's economy improves, interest rates can be expected to rise. But, until this week, most observers expected the ECB to wait until March, by which time annual pay negotiations would be completed in most euro-zone countries.

"Why wait when you are convinced that all indicators point to an increased risk to price stability? We were afraid to wait because if we waited, we would run the risk of being forced to do more than we have done now," he said.

In other words, if the Bank waited until March, it might have felt under pressure to raise rates by half a percentage point rather than a quarter. It would also run the risk of seeing the euro slide even further below parity against the dollar. This would not only encourage inflation but would undermine public confidence in the currency.

The impression that the ECB panicked in the face of the euro's disastrous performance on exchange rates is reinforced by the fact that the Bank departed from its policy of preparing the markets for each interest rate move well in advance. Mr Duisenberg reacted sharply to the accusation of panic yesterday, pointing out that he expressed his concern over the exchange rate after a meeting of EU finance ministers in Brussels on Monday.

His vice-president, Mr Christian Noyer, made similar noises at the World Economic Forum in Davos this week and the president of the Bundesbank joined the chorus soon afterwards.

"I don't think the movement today will come to anyone as a big surprise," Mr Duisenberg said.

But this week's remarks, which were enough to persuade many analysts that a rate rise was on the way, were a far cry from the three-month campaign to massage market expectations in advance of last November's interest rate rise. And Mr Duisenberg has claimed repeatedly that the Bank's policy is to make substantial moves on interest rates - and not to make them too often.

Mr Duisenberg's aggressive response to the suggestion that yesterday's decision was a panic move persuaded many in Frankfurt that the suspicion was well founded. But instead of shoring up confidence in the currency, the ECB may simply have created the impression that the financial markets play a bigger role in determining the Bank's monetary policy than Mr Duisenberg would like to admit.

One reporter asked if, in view of the modesty of yesterday's increase, we could expect another rise in interest rates soon. But by this time, Mr Duisenberg was scarlet with indignation at being faced with impertinent questions and was in no mood to indulge this one. "You can expect whatever you want," he snapped.