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BoE Raises Key Rate: Is the ECB Next?

by: The Prudent Investor July 05, 2007 | about stocks: EZU / FEU / FEZ / FXE / IEV / VGK    
The Prudent Investor

The Prudent Investor

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European markets showed little reaction to today's interest rate decisions. The Bank of England (BoE) raised its key lending rate by 25 basis points to 5.75%, continuing the global upward spiral in interest rates. The BoE based its decision on upside risks in inflation. The European Central Bank [ECB] stayed put and left the key lending rate unchanged at 4% despite a runaway monetary supply. ECB president Jean-Claude Trichet said that credit in the Euroarea was ample at present high levels. He also hinted that the next G7 meeting could release a statement on exchange rates. The Euro softened 70 ticks to $1.3590 after trading as high as $1.3660 with traders expecting no more action on behalf of the ECB until September.

In his introductory statement Trichet said economic conditions were favorable in the Euroarea, but there were some potential risks.

The risks surrounding this favourable outlook for economic growth are broadly balanced over the shorter term. At medium to longer horizons, the balance of risks remains on the downside, owing mainly to external factors. These relate in particular to fears of a rise in protectionist pressures, the possibility of further increases in oil prices, concerns about possible disorderly developments owing to global imbalances and potential shifts in financial market sentiment.

While inflation has remained a decimal below the ECB's upper target range of 2% the longterm explosion of monetary expansion shows no signs of a slowdown. Monetary supply M3 growth picked up again and rose from 10.4% to 10.7% in May (pdf file). The ECB's target growth rate for M3 is 4%.

Despite the surge in M3 the ECB did not have much of a choice at today's governing council meeting. Europe's economic expansion bases partly on a not too strong Euro as further appreciations of the common currency would hamper export growth. Trichet conceded that the situation of the individual economies of the Euro members present a very varied picture but did not go deeper into that matter.

It can be expected that the ECB will stay on hold unless energy prices darken the inflationary outlook again, pushing the official consumer price appreciation beyond the 2% target. This is already the case. Crude oil traded above $72 on Thursday.

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