Rate rise signals ECB serious about inflation

FRANKFURT/SAN SEBASTIAN, Spain (Reuters) - The European Central Bank's interest rate rise sends a signal that it is serious about combating inflation, policymakers said as they staged a public relations offensive to justify Thursday's increase.

A day after raising rates to a seven-year high of 4.25 percent, policymakers around the 15-nation region denied that the increase would choke economic growth and said soaring inflation was a bigger danger to consumers.

Luxembourg's Yves Mersch said the ECB could do little to influence soaring international commodity prices but it could take steps to head off euro zone wage pressures. "We are sending a signal today which shows that we are determined to act against home-made inflation," he told the Luxemburger Wort newspaper.

Inflation rose to a record 4 percent in June and policymakers have vowed to prevent these high rates from pushing up inflation expectations, prompting workers to demand big pay rises and firms to jack up their prices.

Expectations calculated from yields on some inflation-linked bonds are at record highs and ECB Executive Board member Jose Manuel Gonzalez-Paramo said it was vital to keep these in check.

"If these expectations become permanent in the system, we are lost," he told a seminar in San Sebastian, Spain.

The ECB raised rates by 25 basis points but President Jean-Claude Trichet said the Governing Council had no bias in favor of further rate moves, damping bets on another increase soon.

Other policymakers including Italy's Mario Draghi, Germany's Axel Weber, Cyprus's Athanasios Orphanides and Austria's Klaus Liebscher, gave little away about the future path of rates, but backed Trichet's message of rising inflation worries.

"When it was understood that mid-term inflation risks were on the upside, the decision was necessary," Draghi said in a speech in Mirandola, northern Italy. "Not acting on mid-term inflation expectations would have allowed an erosion of purchasing power."

Orphanides said the rate rise aimed at checking price risks, saying: "Nobody can question the negative impact of inflation on income purchasing power, particularly to vulnerable groups of the population."

Economists viewed the rate rise as a warning by the ECB that it was serious about tackling inflation, despite slowing economic growth and protests from European trade unions and some politicians.

"This was a warning shot fired in the air. The next one would be aimed at the legs of the euro zone's economy, should it prove necessary," said UniCredit economist Marco Annunziata.

Portuguese Finance Minister Fernando Teixeira dos Santos joined politicians from Germany, Spain and France in questioning the impact of higher interest rates on economic growth.

"The decision by the ECB was taken in order to ensure price stability, but I cannot ignore that it will certainly have an effect of putting a brake on and slowing down European economic activity," he told Reuters.

But European Commission President Jose Manuel Barroso backed the ECB's decision, saying it was important to show commitment to fighting rising prices. "Inflation is a real threat," Barroso said in Brussels.

"When it comes to inflation, I have more confidence in the positions of the central banks than of politicians," he said, apparently taking a swipe at French President Nicholas Sarkozy for his criticism of the ECB.

INFLATION TO STAY HIGH

Trichet himself, in interviews with Dutch, Irish, Spanish and Italian television, stuck closely to the message that the best contribution that the ECB could make to economic growth was achieving price stability.

The ECB defines this as inflation of below but close to 2 percent and policymakers said there was little chance of achieving their goal in the short term.

Still, they differed slightly on the outlook for the next few months. Weber told German television station ARD that inflation was likely to stay around 4 percent during the summer, a view shared by Gonzalez-Paramo, but Austrian colleague Klaus Liebscher said it could go higher still.

"I cannot rule out a transitory further rise in the inflation rate, the extent of which is open," Liebscher told a business publicists' club in Vienna. "But I stick to the scenario that during 2009 inflation will moderate, although will still be above our definition of price stability."

Mersch said the ECB took into account factors including slowing economic growth, financial market tensions and high uncertainty. But he was less optimistic about growth than he was two weeks ago, when he predicted that the second quarter would be the low point for the economy.

"We should reach the lowest point in the middle of the year," he told Luxembourg's Tageblatt newspaper. "When exactly growth will pick up again is hard to say. The ECB's forecast stands: the economy is growing more slowly, but it is growing."

(Additional reporting by Andrea Le Pera in Mirandola, Italy, Eva Komarek in Vienna, Ruben Bicho in Lisbon, Michele Kambas in Nicosia and William Schomberg in Brussels; editing by David Stamp)