The euro hit a year high against the dollar yesterday after the European Central Bank (ECB) put the euro zone on alert that interest rates would almost certainly rise again next month - and that a larger than usual half percentage point increase could not be ruled out. Marc Coleman, Economics Editor, reports.
The rise reflected the strength of the euro zone's economic recovery and ECB fears about inflationary dangers ahead.
The euro closed at $1.2711, up 0.6 per cent on the day after earlier hitting $1.2723 - its highest since last May - as ECB president Jean-Claude Trichet's continued mention of the word "vigilance" in his statement reinforced expectations in the market for another rise in interest rates next month. Sterling also hit a 12-month high of $1.8434.
"It's a continuation of the Trichet move," Shaun Osborne, chief currency strategist at Scotia Capital in Toronto, said of the euro's mid-afternoon rise in New York.
Mr Trichet did not mention the euro's recent rise, limiting himself to noting that the Group of Seven finance chiefs' recent communique on currencies did not signal any change in their view on the dollar.
However, Mr Trichet acknowledged soaring oil prices could hit economic growth and analysts added that further euro strengthening could also slow the pace of monetary policy tightening in the months ahead.
Ulrich Kater, economist at DekaBank in Frankfurt, said "the risk is of policy not keeping pace with world economic growth - and that central banks underestimate the speed of global expansion, especially in emerging markets".
The ECB left its main interest rate unchanged at 2.5 per cent yesterday, but Mr Trichet later stressed that the governing council's "particular vigilance" in the face of inflation risks.
He has used the word "vigilance" in recent months to signal an interest rate increase was in the pipeline.
The ECB raised rates by a quarter percentage point in December and March. Mr Trichet said a strengthening of the economic recovery would warrant the "further withdrawal" of an accommodative monetary policy - a hint that the ECB was looking beyond just another quarter point rise.
However, he deliberately sidestepped questions about whether a half percentage point rise was possible in June, suggesting that the ECB was happy with the financial markets attributing a roughly 25 per cent chance to such a move.
Some governing council members might favour a larger than usual interest rate rise next month when the ECB meets in Madrid. Spain has the euro zone's highest inflation rate and the country's house price boom is worrying European Union policymakers.- (Additional reporting, Reuters and Financial Times service)
