Tug of War Over European Central Bank Interest Hike | Business| Economy and finance news from a German perspective | DW | 30.11.2005
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Tug of War Over European Central Bank Interest Hike

The European Central Bank (ECB) is expected to raise its benchmark interest rate on Thursday. Some economists worry it could hurt Europe's weak economic recovery, but the ECB wants to keep inflation in check.


The ECB in Frankfurt wants to keep inflation under 2 percent

ECB heads say their widely expected rate hike of 25 basis points, to 2.25 percent, is meant to maintain price stability and keep inflation in the euro zone under control.

Euro-zone inflation eased in November to 2.4 percent on a 12-month basis from 2.5 percent the previous month, a first estimate released Wednesday by the EU's Eurostat statistics agency showed.

Private economists had expected inflation to remain stable in November from October after peaking at 2.6 percent in September amid a sharp spike in oil prices. Although inflation was inching lower, it remained well above the European Central Bank's preferred level of close to but less than 2.0 percent.

Jean-Claude Trichet

Jean-Claude Trichet, president of the European Central Bank

"Maintaining price stability is a way of securing trust," said ECB President Jean-Claude Trichet. "That, in turn, is necessary for more growth and employment."

He was answering a chorus of critics who have warned that any interest rate increase could put the brakes on Europe's nascent economic recovery.

Positive economic trend

The euro-zone economy grew at a 0.6 percent clip in the third quarter as the 12-nation bloc clocked the strongest quarterly growth since the beginning of 2004, the European Union's Eurostat statistics agency said.

Eurostat's figures showed an export-driven economic recovery gradually gathering steam in the 12 nations using the euro after growth of 0.4 percent in the second quarter and 0.3 percent in the first quarter.

DAX - Deutscher Aktienindex, Börse in Frankfurt am Main

Recent economic news has been good in Europe

That growth, along with soaring oil prices, has been enough for central bankers to worry that inflation is creeping upward. They are eager to keep prices and especially wages from going up and therefore say the time for a slight rate increase is right. The guardian of the euro has held its central "refi" refinancing rate steady at 2.0 percent since June 2003. And the last time the ECB tightened monetary conditions in the single currency area was in October 2000.

Growth accelerated to its fastest pace in more than a year in the third quarter, giving sufficient confidence to the ECB to warn about higher interest rates without worrying too much about the impact on growth," said Mitul Kotecha, an analyst with the corporate and investment bank Calyon.

Too early?

But the ECB has come under fire from several euro-zone finance ministers, business groups, and the Organization for Economic Cooperation and Development (OECD), who argue central bankers are moving too quickly to raise interest rates.

"With the recovery expected to be moderate and any oil-price induced second round effects on wage inflation being uncertain, monetary policy should remain on hold for some more time, with tightening starting in earnest later next year," the Paris-based OECD said in its biannual economic outlook.

Jean Claude Juncker EU Parlament

Luxembourg's Juncker was critical of the hike, but has softened his stance

Jean-Claude Juncker, prime minister of Luxembourg -- who also serves that the country's finance minister -- said earlier this week that the rate rise was not absolutely necessary. However, he backed off from his reservations on Wednesday, reflecting the resignation of several detractors that an increase is coming, like it or not.

"If the rate increase is moderate, it is not going to kill the dynamics of growth," he said in Brussels.

Criticism from Germany

That opinion is not shared by Gustav Horn, an economist at the Macroeconomic Policy Institute of the Hans Böckler Foundation. He calls the expected hike a bad signal for Europe and "catastrophic" for Germany, namely because already weak consumer demand could be further dampened by an expected 2007 increase in value-added tax (VAT).

Gustav Horn

Gustav Horn says the hike will be a disaster for Germany

"Those things taken together could lead to an economic collapse," he said in an interview with DW-TV. Germany is in the "worst consumer crises of postwar history," he added. "We need growth rates of over 2 percent over several years before we can hope for real improvement."

Last week, a survey of businesses in Germany found that business confidence declined in November more than expected, suggesting that while Europe's largest economy was growing, it was still fragile. Two other recent surveys reported a drop in business confidence in Belgium and lower consumer spending in France.

Horn said Europe as a whole was likely to suffer from the, in his mind, premature increase in rates.

"The numbers (in Europe) look better, but an upturn hasn't developed yet," he said.

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