ECB warns on rates, euro zone seals deal on fund

Wednesday, 23 March 2011 01:03 - - {{hitsCtrl.values.hits}}

BRUSSELS/FRANKFURT, (Reuters) - European central bankers signalled that they stood ready to raise interest rates next month despite uncertainty linked to Japan’s nuclear crisis and the ongoing struggles of euro members Greece, Ireland and Portugal.

Euro zone finance ministers meeting in Brussels sealed an agreement on funding of a new safety net for the bloc, but left it to a summit of EU leaders later in the week to work out a deal with Ireland on debt relief and forge a compromise on boosting an existing rescue facility.

Meanwhile, Portugal’s government warned that it could step down even before that summit takes place if opposition parties block new spending cuts in a parliamentary vote expected on Wednesday. That would ratchet up pressure on the country to follow in the footsteps of Greece and Ireland and seek a bailout from the European Union and International Monetary Fund (IMF).

Investors appear increasingly confident that the bloc can prevent its sovereign debt woes from spreading beyond Portugal, given progress on a package of anti-crisis measures that leaders are expected to sign off on by Friday.

The risk premium markets demand to hold Spanish 10-year debt

, for example, has fallen to its lowest level since early February, and the euro pushed above $1.42 on Monday for the first time in over four months.

Rising inflation in core European countries like Germany has convinced the European Central Bank it is time to push up its benchmark rate, which has stood at a record-low 1.0 percent since May 2009.

ECB President Jean-Claude Trichet shocked markets in early March by saying the bank could raise rates as early as April and he made clear on Monday that this message was still valid even after Japan’s devastating earthquake, tsunami and nuclear disaster.

“VERY HIGH VIGILANCE”

“Inflation in the euro area is on the rise,” Trichet told the Economic and Monetary Affairs committee of the European Parliament.

Several of Trichet’s ECB colleagues drove home the warning in even stronger language. Luxembourg’s central bank chief Yves Mersch used the term “very high vigilance” to describe the bank’s approach and Italy’s Mario Draghi said policymakers stood ready to act in a “firm and timely way”.

Higher rates could make it more difficult for the economies of Greece, Ireland and Spain to recover as all have a high percentage of floating rate mortgages, fragile banking sectors and major budget consolidation programmes in place. The hawkish talk from ECB officials came as European finance ministers met in Brussels to hammer out the final details of a deal that is expected to be approved by EU at a two-day summit in Brussels that starts on Thursday.