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Business

ECB Raises Interest Rates Amid Soaring Inflation

The European Central Bank (ECB) raised its main interest rate to 4.25 percent on Thursday, its first increase in more than a year amid spiraling euro zone inflation and soaring oil prices.

European Central Bank headquarters in Frankfurt

The decision had been expected since euro zone inflation hit a record four percent in June

The ECB's 21-member rate-setting council defied increasing political opposition to a tighter monetary policy in the 15-member euro zone by raising its benchmark refinancing rate by 25 basis points to 4.25 percent on Thursday, July 3.

The decision had been widely expected since ECB President Jean-Claude Trichet raised the possibility last month and euro zone inflation hit a record 4 percent year-on-year in June.

While analysts had expected the rate increase, they are more divided as to whether it will represent a one-off attempt by the ECB to ward off inflationary pressure or set the stage for further increases.

As a result, with the rate hike considered a done deal, the focus of financial markets will again be on Trichet's press briefing for indications as to the bank's future plans.

However, ahead of the ECB announcement, oil prices bounded ahead by more than 1 percent to breach the $145-a-barrel mark to hit a new all-time high with soaring food and energy prices having sparked a global pickup in inflation.

"Sending the wrong signal"

This in turn has raised concerns that central banks around the world will be forced to raise borrowing costs just as international economic growth is losing momentum.

Senior ministers from Germany, Spain and France cautioned the European Central Bank against raising interest rates last weekend, warning it could stifle growth.

German Finance Minister Peer Steinbrueck said week higher rates risked worsening a slowdown in growth.

"The ECB has to consider that they could possibly send the wrong signal with an interest rate increase because it could have a pro-cyclical impact at a point when the economy is slowing down," he told German weekly Der Spiegel.

Steinbrueck's view was echoed by Spanish Prime Minster Jose Luis Rodriguez Zapatero.

"Now, it has to have a certain flexibility, especially as European inflation comes essentially from the price of oil and food, not from an excess of internal demand," Zapatero said in an interview with daily El Pais.

The ECB rate hike and the growing global economic uncertainty also comes as part of the build-up to this month's summit in Japan of the Group of Eight leading industrial nations where the troubled state of the world economy could dominate proceedings.

Also on Thursday Sweden's central bank, the Riksbank, announced that it was joining the push to higher rates by lifting its benchmark repo rate by 25 basis points to 4.5 percent.

This came in the wake of data showing annual inflation in Sweden climbing to 4 percent in May to hit its highest rate in more than 14 years.

Adding to the growing worries about the economic risks posed by inflation, figures released on Thursday showed consumer prices in Switzerland jumping to a 15-year high of 2.9 percent in June, consequently increasing the pressure on the Swiss National Bank.

Inflation peaks in euro zone

Euro zone inflation also shot up to a 16-year high of 4 percent in June, preliminary data announced this week showed. Inflation in the currency bloc is now double the ECB's target of "close to, but just below 2 percent."

Trichet surprised markets last month by signalling that a rate hike could be in the pipeline, saying in his regular press briefing that the bank's governing council was in a state of "heightened alertness" about the risks posed by inflation.

In the meantime, ECB figures released last week pointed to a sustained rise in the amount of money in circulation in the euro zone with the so-called M3 money supply chalking up a 10.5-percent annual rate in May. The ECB sees M3 as an indicator of future price trends.

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