EU interest rates unchanged now but likely to rise

The president of the European Central Bank (ECB), Mr Wim Duisenberg, has given his strongest indication yet that the cost of borrowing in the euro zone is on the way up. Both the ECB and the Bank of England yesterday left interest rates unchanged at policy-making meetings, but the financial markets expect increases over the coming months. Shares in Frankfurt, Paris and London all surged after the announcements, while the euro held its value against the dollar.

Speaking after a meeting of the ECB's governing council in Frankfurt yesterday, Mr Duisenberg said the present regime of low interest rates was designed to boost economic growth in the euro area.

"We have had a truly accommodating monetary policy stance over more than a year. We are assessing whether this period of an accommodating monetary stance has had enough time. We are turning our minds now to the future and to the fact that we have to adopt and have a monetary policy stance that will be conducive to sustained, non-inflationary growth," he said.

And while it was not the ECB's inclination to "play a very activist role in trying to fine-tune the economy" and take a pre-emptive strike to nip inflation in the bud, "on the other hand, any measures . . . will always have to be, and will be, timely", he warned.

His comments were interpreted by analysts as a clear indication that euro-zone interest rates will increase, although there is disagreement over whether the ECB will announce an increase at its next council meeting in November, or whether it will wait until early in the new year.

Prices on the financial markets indicate an expectation that interest rates in the euro zone will be 1 to 1.5 percentage points higher at the end of next year than they are now.

This would mean some increase in repayments for Irish borrowers over the next year, although, as mortgage rates have fallen by over a point recently following the arrival of Bank of Scotland, the rise over the next year may still leave variable mortgage rates at low levels of around 5 per cent.

In the UK, the Bank of England did not give any details about its decision making, although the minutes of the meeting will be published next month.

Its monetary policy committee cited strong housing prices and consumer confidence, as well as improving world growth and a tight labour market, when it raised its key short-term repo rate last month and these factors are expected to lead to further rises.

According to Mr Aziz MacMahon, treasury economist at Ulster Bank, the Bank of England may leave rates on hold over the rest of this year. "There have been mixed signals recently and the recovery may not be as robust as people thought."

However, he added, the US Federal Reserve was in a different position and was likely to raise rates in early November.

According to analysts, if the ECB wants to raise interest rates before next spring, it will have to do so next month. December is seen as an unsuitable month to increase rates, in view of fears that the millennium bug could distort liquidity flows over the new year.

Raising rates during the first few months of next year could have an impact on a crucial round of pay negotiations in Germany, which accounts for half of the industrial production of the euro area, encouraging unions to demand bigger settlements.

Mr Duisenberg painted an optimistic picture of Europe's economic prospects during the coming months, despite a slowdown in output during the second quarter of this year. A slight rise in inflation is, he believes, mainly due to a temporary increase in oil prices but he warned unions against using the inflation figures to justify excessive wage claims.

According to Mr Pat O'Sullivan of AIB, the ECB will hold rates as they are until the new year despite the more bullish tone from Mr Duisenberg. "Outside of oil prices, there is no real sign of a pick-up in inflation and given the fragile nature of the recovery they may wait until February or March to raise rates,"