Euro predicted to drop further as rate rise fails to convince

The European Central Bank (ECB) appeared increasingly powerless in its efforts to halt the decline of the euro yesterday as the currency hit new lows within minutes of its decision to raise interest rates by another quarter of a percentage point.

As traders in Frankfurt predicted the euro would soon be worth less than $0.90, one of Germany's leading economists called on the ECB to intervene in the market to boost the euro.

The markets had been expecting yesterday's rate rise of 0.25 per cent, which followed a number of warnings by ECB board members that the Bank was worried about the threat of inflation in the euro zone. In a statement following its fortnightly meeting in Frankfurt, the ECB's governing council said the weak euro, a medium-term risk to price stability and strong economic growth, persuaded it to tighten monetary policy.

"The governing council expressed concern about upside risks to price stability which, given the prospects for strong economic expansion, arise from strong growth in monetary and credit aggregates, as well as from the present level of the exchange rate of the euro," the statement said.

The Bank repeated its contention that the euro's exchange rate did not reflect the strong economic fundamentals of the euro zone.

Most economists agree, but Frankfurt traders said yesterday the momentum driving the euro downwards was now so strong that nothing the ECB did would make any difference to the exchange rate in the short term.

Prof Norbert Walter, chief economist at Deutsche Bank, believes that, if the euro falls below 90 US cents, central bankers will be forced to intervene in the market.

"We have $250 billion (€274 billion) too much in dollar reserves in the cellars of Europe's central banks. And they're sitting on them and waiting until the exchange rate gets worse before they finally sell them," he said. The ECB is reluctant to intervene unilaterally in the markets and the US is unlikely to agree to any concerted action to boost the euro. Mr Dieter Wermuth, an economist at Tokai Bank, who believes the euro could be worth as little as 70 cents before the trend turns, recalled the last period of dollar euphoria in the 1980s when the dollar reached similarly improbable heights.

"That was not fundamentally justified either but was based on the limitless optimism of the USA. The only thing that can help the euro is a crash followed by recession," he said.

Even indications yesterday that inflation may be becoming a serious problem in the US economy failed to halt the euro's decline. The US employment cost index, a broad gauge of what employers pay in wages, salaries and benefits, rose at the fastest pace in more than 10 years. The index jumped 1.4 per cent, much higher than the 0.9 per cent rise expected by economists.

"If there is one statistic that is going to make the Federal Reserve raise interest rates by half a percentage point instead of a quarter, this is it," said Mr Richard Babson, chairman and president of Babson-United Investment Advisors Inc. "The market is finally waking up to the fact that there is inflation embedded in the economy."