Europe raises interest rate to 7-year high

The European Central Bank defied deepening gloom over the eurozone's prospects and intense political pressure yesterday to raise interest rates to their highest level for almost seven years.

The quarter-point increase to 4.25 per cent came after Jean-Claude Trichet, the President of the ECB, sounded a warning on Wednesday that eurozone inflation could “explode” without decisive action.

The rise was the first for a year and took rates to a level last seen in September 2001, before a series of cuts in the wake of the September 11 terrorist attacks on the United States.

The ECB’s decision to spurn pleas from European leaders, led by President Sarkozy of France, to hold fire came after a jump in eurozone inflation to 4percent in June set alarm bells ringing over rising price pressures.

Anxieties over mounting inflationary risks in the eurozone were inflamed further this week after a fresh jump in the cost of goods leaving factories. Producer output prices leapt by 1.7 per cent in May to stand 7.1 per cent up on a year earlier, driven by an 18.2 per cent year-on-year rise in energy costs.

The ECB’s move came despite bleak figures in the latest purchasing managers’ survey from the eurozone which showed that its vast services sector, the engine room of its economy, had shrunk in June for the first time since mid-2003.

The unanimous verdict from the ECB Governing Council came under immediate attack from the European Trade Union Confederation. “The decision is dangerous, counterproductive and not necessary,” it said.

However, Mr Trichet soothed edgy markets as he struck a neutral stance over the threat of more rate increases to follow, leaving the door open to further action but signalling that the ECB was in no hurry to tighten policy again.

“Starting from here, I have no bias,” he said during a press conference in which he avoided using any of the codewords he had previously uttered to pave the way for rate moves.

Although Mr Trichet played down the significance of his choice of words, European stock markets took reassurance from his comments to end higher after their most volatile trading day in more than three months.

Eurozone interest rate futures also rose, pricing in a reduced chance of further, early rate moves.

The ECB’s move did little to dispel growing fears over the outlook for the eurozone economy, however, as yesterday’s purchasing managers’ survey was a catalogue of gloom for services companies across the 15-nation bloc.

Activity in the services sector stagnated or fell across most eurozone countries last month, the survey showed.

It also indicated that business expectations among services companies had slumped to their lowest since November 2001, as inflows of new business fell and outstanding business contracted at the fastest pace since mid-2003.

Economists said the growing signs that the eurozone economy was faltering badly, even as price pressures continued to build, were likely to make yesterday’s interest rate increase a one-off move for the year.

Gloom across the Atlantic over prospects in the US also deepened as the latest snapshot of American services companies from the Institute of Supply Management also showed a surprise fall in the sector’s activity last month, while employers cut staff for the sixth consecutive month in the longest such run of job losses since 2002.

About 62,000 jobs were cut in the US last month, bringing losses for the year so far to 438,000, and applications for unemployment benefits leapt to 404,000 last week – a level associated with past recessions.