Hawkish ECB hints at pre-emptive rate rises

Leading members of the European Central Bank yesterday warned that it could soon raise interest rates for the first time in five years to combat rising inflation and stifle credit growth. An increase could come as early as December.

Axel Weber, an ECB council member and the head of Germany's Bundesbank, raised the bank's hawkish tones by pointing to the need for pre-emptive action to maintain price stability and prevent inflationary expectations feeding through into rises in wages and prices.

Amid fresh evidence that the eurozone's economies, notably that of Germany, are recovering faster than expected, Erkki Liikanen, a council member and the head of Finland's central bank, said both of the ECB's tools for monitoring inflationary risks - analysis of the real economy and the supply of money and credit - were flashing significant warning signs.

Their comments, following remarks last week by Otmar Issing, the ECB's chief economist, led some analysts to argue that the bank could raise interest rates at its December meeting and set in train a series of increases to 3% next year. Rates have been held at 2% since June 2003.

But most economists expect the ECB, which next meets on November 3, to stay its hand until at least the first quarter of next year when firmer evidence ofeconomic growth and inflationary pressures is available.

Driven by steeper energy and petrol prices, eurozone inflation reached 2.6% in September, above the ECB's 2% target, and leading council members have suggested that it may not fall back towards the target until late next year or in 2007.

Both Mr Weber and Mr Liikanen conceded that inflationary expectations were under control but Mr Liikanen insisted that "significant risks to their upside need to be taken into account", while Mr Weber said: "The need sometimes arises to act pre-emptively, looking at risks for inflation."

Mark Wall, a senior economist at Deutsche Bank, said the ECB was likely to raise rates at one of its forthcoming meetings, with the likelihood of a December rise "slightly above 50%".

"It would be only 25 [basis] points but we think it's the start of a process of bringing rates back up to a more normal or neutral level of, say, 3%," he said.

Peter Dixon at Commerzbank said: "The inflation pass-through effects are likely to be limited and the economy is not yet strong enough to withstand a hike. But the ECB is clearly trying to tell us that a hike is coming - the only question remains, how soon? In our view, probably later than many think."

But his colleague Michael Schubert said a December rise could no longer be excluded, especially if economic data and the bank's own analysis due next month pointed to a strong recovery.

David Page at Investec said: "It is the continued signs of resurgence in the eurozone economy that [are] likely to lead to higher rates, though a sharp rise in the euro, forecast over the next six months, should delay such a tightening until mid-next year."