Rate rise necessary to protect against inflation - Duisenberg

Interest rates rose yesterday for the first time since the launch of the euro when the European Central Bank (ECB) increased its main lending rate by half a percentage point to 3 per cent. The increase had been anticipated for some time but some analysts were surprised by the size of the rate rise, which returns rates to the level prevailing before April, when the ECB last changed its rates.

"We were very sure that if we moved by 25 basis points we would immediately have created the expectation that another change was imminent. We want to calm down expectations without saying when the next change may be," the ECB president, Mr Wim Duisenberg, told reporters following a meeting of the bank's governing council.

Although the ECB expects inflation in the euro zone to be 1.51.7 per cent next year, comfortably below its upper limit of 2 per cent, Mr Duisenberg insisted that a rate rise was necessary to protect against future inflationary pressures.

"The main argument for raising the interest rates was the fact that since around the beginning of the summer the balance of risks to future price stability has gradually been moving towards the upside. In fact, the economic situation in spring 1999 had given rise to concern about downward risks and had led to a precautionary interest rate reduction by 50 basis points on 8 April 1999. However, the current economic environment is far more favourable," he said.

The decision to raise rates was unanimous and Mr Duisenberg rejected the charge that the ECB had allowed high inflation in "peripheral" states such as Ireland, Spain, Portugal and the Netherlands to precipitate a rate rise that could stall the recovery in core euro-zone states such as France and Germany.

Mr Duisenberg left little doubt that the downward trend in interest rates had ended and hinted that the next increase in rates could come as early as the spring of next year. When the ECB cut rates in April, Mr Duisenberg underlined the durability of the new rate by declaring "This is it!"

He refused to repeat the declaration yesterday but insisted that it was the ECB's policy to remain as predictable as possible as far as the financial markets were concerned.

"We do want to be predictable. We do want to be credible. But that doesn't rule out the possibility that we may surprise the markets some time," he said.

Analysts in Frankfurt yesterday suggested that the ECB may have difficulty in raising rates too soon, especially if headline inflation falls in the first few months of next year, as expected. There are signs that wage claims in Germany, which accounts for half of the industrial production in the euro zone, may be moderate.

One of the factors that contributed to yesterday's decision was the strong growth in money supply in recent months, which Mr Duisenberg said was evidence that there was ample liquidity in the euro zone. The ECB's monetary policy is based on two "pillars", consumer prices and money supply, which Mr Duisenberg said had now come into alignment.

"In April, we had the two pillars pointing in different directions. That made making a decision more difficult. Today, we have both pillars pointing in the same direction, namely towards an increased risk to price stability as we perceive it," he said.