ECB signals more rate rises to come, helps Portugal

FRANKFURT Thu Jul 7, 2011 12:51pm EDT

The illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in Frankfurt April 5, 2011. REUTERS/Kai Pfaffenbach

The illuminated euro sign is seen in front of the headquarters of the European Central Bank (ECB) in Frankfurt April 5, 2011.

Credit: Reuters/Kai Pfaffenbach

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FRANKFURT (Reuters) - The European Central Bank raised interest rates for the second time in three months on Thursday and signaled a further hike is likely this year to tackle inflation despite the intensifying euro zone debt crisis.

The ECB also offered help to hard-pressed Portugal after ratings agency Moody's downgraded its debt to junk status this week, pledging to keep providing it with liquidity regardless of ratings.

On Greece's debt troubles, President Jean-Claude Trichet stuck to the bank's view that any rescue should not trigger a default or a payout in credit insurance, a stance that pushes the problem back to governments.

"We will continue to monitor very closely all developments with respect to upside risks to price stability," Trichet told a news conference after the bank raised interest rates by 25 basis points to 1.5 percent -- its second rise this year.

Economists said beforehand that use of that phrase would signal a further rate rise in 2011, likely to be in the last three months of the year.

"Today's news conference has made crystal clear that the ECB remains geared toward further monetary tightening, despite the lingering debt crisis," said ING economist Martin van Vliet.

Although financial markets are anxious to know what steps the ECB might take if the euro zone crisis worsens further, Trichet repeatedly refused to discuss them and said he would prefer instead to discuss traditional monetary policy.

Leaving the news conference, Trichet said he hoped next month's briefing would focus primarily on monetary policy rather than "other issues."

The ECB has proved a major stumbling block in agreeing a second rescue plan for Greece as it has threatened to refuse restructured Greek bonds as collateral in its lending operations in the event of a default or a "restricted default," which ratings agencies are threatening to impose.

"We say no to selective default, no to a credit event," Trichet said.

Refusing to accept Greek bonds as collateral would deprive Greek banks of the funds on which they rely, crippling the Greek economy and risking contagion to other euro zone economies. Most economists expect the ECB to baulk at that and keep banks afloat somehow.

Berenberg Bank economist Holger Schmieding said Trichet did not give a clear answer as to whether the ECB would simply accept a rating agency verdict of 'selective default' or use its own judgment.

"His comments seem to suggest that the ECB would defer to a unanimous verdict of the rating agencies on this. But as he did not answer it fully clearly, the ECB may be leaving a little escape route open," Schmieding said.

Trichet did, however, in the wake of Moody's Portugal downgrade, join in criticism of the "oligopolistic" role of ratings agencies, saying there way they operated was "not optimal."

Q4 RISE EXPECTED

Euro zone inflation held at 2.7 percent in June, well above the ECB's target of just under 2 percent and Trichet said the bank's interest rates remained accommodative even after Thursday's increase.

The rise in the ECB's benchmark interest rate to 1.5 percent was widely expected after the bank's recent reiterations that it was in "strong vigilance" mode -- code traditionally used to signal a hike.

It also raised its subsidiary overnight deposit and borrowing rates in unison, opting not to re-widen its so-called rate 'corridor' this time around, a decision which ensures the rate hike packs its full punch.

"There are hints that the ECB is currently minded to maintain its current pace of monetary policy tightening, which would suggest another 25 basis point interest rate hike to 1.75 percent in the fourth quarter," said Global Insight economist Howard Archer.

JPMorgan economist Greg Fuzesi said: "We expect the ECB to accompany the next set of staff forecasts in September with its "strong vigilance" signal, setting up a 25 basis point move in October."

HELPING HAND TO PORTUGAL

The downgrading of recently bailed-out Portugal's credit rating to junk rattled financial markets on Wednesday and cast new doubt on European efforts to rescue distressed euro zone states without debt restructuring.

The ECB has pledged to keep liquidity flowing to euro zone banks that need it, and Trichet said Portuguese debt would be accepted by the ECB as collateral for now, come what may.

"We have decided to suspend the application of the minimum credit rating threshold ... for the purpose of Eurosystem credit operations in the case of marketable debt instruments issued or guaranteed by the Portuguese government," he said.

"This suspension will be maintained until further notice."

The head of the Portuguese Banking Association (APB), Antonio de Sousa, hailed as "very important" the ECB decision to waive its rules on minimum credit ratings for accepting Portuguese debt as collateral for its loans to banks.

(Editing by Mike Peacock)

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