The latest rise in interest rates will encourage strong growth with low inflation throughout the euro zone, the president of the European Central Bank (ECB), Mr Wim Duisenberg, claimed yesterday. But Irish economists fear the increase of half a percentage point could drive up prices in the Republic.
The euro rose sharply against other currencies immediately after the announcement but fell back later in the afternoon, stabilising just below $0.96.
Speaking in Frankfurt after a meeting of the ECB's governing council, Mr Duisenberg said that the euro's recent weakness had contributed to a higher risk of inflation in the medium term as higher import prices feed into higher prices in the shops.
"Today's increase in ECB interest rates is a decisive step to address these upside risks to price stability and it will contribute to the continuation of non-inflationary growth in the euro area," he said.
Mr Duisenberg acknowledged that some members of the governing council initially favoured a smaller increase, but insisted that by the end of the meeting the decision to make a more decisive move was unanimous.
The increase, which is expected to be the last move on interest rates until the autumn, should help to slow the increase in Irish house prices and consumer spending. But it will also feed through to a rise in inflation, which is heavily affected by mortgage costs as mortgage rates are one of the items included in the basket of goods used to produce the consumer price index.
The Republic is more susceptible to this than most other European countries because of the numbers of borrowers on variable rates compared with the European norm of 10 or even 20-year fixed-rate loans. According to Mr Jim Power, chief economist at Bank of Ireland, the rate increase could add 0.6 of a percentage point to Irish inflation in June or July.
Mr Duisenberg was very upbeat about economic growth, predicting that it would exceed 3 per cent this year, which is significantly higher than expected at the end of last year. He added that yesterday's rate increase would allow this growth to continue in a non-inflationary manner.
Governments must be careful not to take advantage of this growth to pour more money into their economies. "This is particularly important in those countries where there is a risk of overheating," he added.
The ECB also announced a move to a variable rate tender in a technical move to increase liquidity in the markets. Market participants said one side-effect would be to increase the rate of one-month money which banks normally base their lending rate on. According to Mr Jim Power, one-month money could head towards 5 per cent with the cap removed. The move comes into effect on June 28th, giving the market time to adjust.
