ECB breaks norm with rate hike

The European Central Bank (ECB) is the first G-4 central bank to begin its exit from its accommodative monetary policy stance after its governing council on Thursday unanimously agreed to raise its benchmark interest rate by 25 basis points to 1.25%.

The decision to hike rates was widely expected by markets and ends a run of almost two years of its main refinancing rate, which was 1%.

At a conference in Frankfurt, Jean-Claude Trichet, the president of the ECB, dismissed reporters' fears the rate hike may destabilise the euro area, instead emphasising the move was warranted in the light of the upside risks to inflation associated with a sharp rise in energy and food prices.

Trichet said global price pressures threatened to un-anchor inflation expectations in the medium term and that the ECB was sending a clear signal that it would not accept or tolerate second-round effects. "It is of paramount importance that the rise in harmonised index of consumer prices (HICP) inflation does not lead to second-round effects in price and wage-setting behaviour and thereby give rise to broad-based inflationary pressures over the medium term," Trichet said.

HICP inflation climbed 0.2 percentage points to 2.6% in March, following a 0.3% increase in euro area real GDP in the fourth quarter of 2010. Uncertainty over the pace of the global recovery in the wake of the devastating earthquake on Japan's north-east coast and continued political unrest in the North Africa and Middle East region had led some to speculate that central banks may delay any monetary policy tightening. However, the ECB said it was intent on normalising rates in order to curb inflation.

The decision to raise interest rates highlights a difference in conviction between the eurozone authority and other central banks over the transience of commodity price increases. For example, the Bank of England have resisted a rate hike despite the rise in energy prices. CPI inflation in the UK was 4.4% in February, according to estimates from the Office of National Statistics. Unlike the ECB, the consensus on the Bank's Monetary Policy Committee is that price pressures emanating from global energy prices are temporary and will not lead to second-round effects.