Europe’s Rate Rise Signals End of Cheap-Money Era


The European Central Bank on Thursday became the first monetary authority in a major developed economy to raise interest rates since the global financial crisis struck—a sign that the long period of extraordinarily easy credit is beginning to come to a close.

In the U.S., where there is less inflation angst than in Europe, the Federal Reserve is unlikely to follow until very late this year or early next. Moving ahead of the Fed is unusual for Europe’s central bank. The Fed moved first in the previous two global monetary-tightening cycles since the ECB was formed 12 years ago—in the late 1990s, and in the mid-2000s.

Global Rates

Rate changes since 2004 in dozens of countries.

Central banks in Canada and Australia, which boosted rates last year, and in the U.K. are expected to raise rates this spring or summer. The Bank of Japan, preoccupied by the devastation of the recent earthquake and a continuing nuclear crisis, is not.

The stakes are high: Moving interest rates by the right amount at the right time will, in large measure, determine whether the recovery from the worst recession since the Great Depression gains momentum, and whether the world can avoid an unwelcome outbreak of inflation.

Seared by the experience of the past few years, central bankers are stepping even more delicately than usual.

On one hand, inflation fears are rising, fueled by higher prices for food, oil and goods and a sense that inflation often follows periods of heavy government borrowing and easy money. On the other, banks and borrowers in many places remain fragile, and growth is too slow to slash still-high unemployment rates.

Vowing to nip inflation in the bud, Europe’s central bank Thursday lifted its benchmark interest rate by a quarter percentage point to 1.25%, even though higher rates will add to already crushing debt burdens in Greece, Ireland, Portugal and Spain.

The tightening of rates came on the day Portugal officially became the third European country to request a bailout from its peers. ECB chief Jean-Claude Trichet made clear the bank is reluctant to keep rates low only to aid the euro zone’s weaker economies. “It is in the interest of all members of the single market, with a single currency, that we maintain maximum credibility for the anchoring of inflation expectations,” he said.


Consumer prices in March in the countries that share the euro was 2.6% above year-earlier levels, well above the ECB’s inflation target of just under 2%.

Many analysts warn that further interest-rate increases would have a damaging effect on the euro bloc’s periphery. Those economies carry crushing private-sector debt loads whose financing is closely tied to short-term interest rates—a lethal cocktail for countries struggling with burst property and debt bubbles.

In Spain, where more than 90% of mortgages are tied to short-term interest rates, a total 0.75 percentage point increase in ECB rates this year—as many analysts expect—would add almost €1,000, or around $1,430, per year to the average Spaniard’s mortgage payment, estimates Fernando Fernandez, professor at IE Business School in Madrid.

The Bank of England, which also met Thursday, decided not to raise rates, despite an inflation rate well above its own target.

Meanwhile, the Bank of Japan offered banks ¥1 trillion ($12 billion) in nearly free one-year loans, a response to the economic damage from the earthquake—but didn’t take the potentially more powerful step of increasing its purchases of Japanese government bonds.

In the U.S., the Fed is about to stop pumping more credit into the economy by completing its planned $600 billion in purchases of U.S. Treasury bonds. But—despite the restlessness of a few of its policy makers—Fed Chairman Ben Bernanke shows no signs of rushing to boost its key short-term rate, near zero since December 2008.

A Wall Street Journal survey this week, to which 53 economic forecasters responded, found they on average expect the Fed to lift rates in January 2012. A third, though, see a move before the end of this year.

According to trading in futures markets, investors anticipate the Fed won’t move its key interest rate to 1.25% until fall 2012.

To consumers and businesses, the divergence among central banks matters less than the policies of their own monetary authority.

“The question for Europe is: Is the ECB acting appropriately to ensure that inflation is low and steady, or is it acting prematurely and putting the fledging recovery at risk?” said Kim Schoenholtz, an economist at New York University’s Stern School of Business.

The differences in monetary policies partly reflect differences among the world’s largest economies. Even in an age of globalization, monetary policy still is focused largely on national or regional conditions.

And inflation is more clearly a threat in Europe than in the U.S right now. “Europe is much closer to full employment than we are because their employment didn’t dip as much…and their inflation rate is higher than ours,” said Edwin Truman, a former Fed official now at the Peterson Institute for International Economics, a Washington think tank.

But the divergent policies also reflect different judgments by central bankers about the risk that the long period of global easy credit and the recent rise in energy and food prices will yield global inflation or asset bubbles.



The ECB move isn’t likely to have any significant impact on the timing of the Fed’s first step toward raising rates, a decision that turns heavily on the health of the U.S. economic recovery and inflation expectations.

One reason the Fed is moving more slowly than the ECB is that, by most estimates, the U.S economy has more spare capacity than Europe, and thus can grow more rapidly before provoking inflation. The U.S. consumer price index was up 2.1% in February from a year earlier; excluding the volatile food and energy sectors, the index was up 1.1%.

When monetary policy moves in different ways and at different speeds, the most visible impact usually is in currencies—and, indeed, that already has shown up. The euro had climbed more than 3% against the dollar since early March when the ECB’s Mr. Trichet strongly hinted that a rate hike was imminent.

On Thursday, though, the euro fell 0.19% to $1.4304—at least in part in response to Mr. Trichet’s assertion at a press conference in Frankfurt that “we did not decide today that it was the first of a series of interest-rate increases.”

However, Mr. Trichet on Thursday indicated the ECB remains concerned about the prospect that higher energy and food prices will seep into prices of other goods, services and wages. “We are extremely alert in this respect,” he said.