European Central Bank projected to raise interest rates on Thursday

04/05/2011 4:34 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The European Central Bank will go first. At least that’s the expectation. The bank meets on Thursday, April 7, and financial markets project that it will be the first of the big three central banks in developed economies to raise interest rates. Traders are right now looking for a move to 1.25% from 1%. Last month the European Central Bank used the “strongly vigilant” language that signaled its last interest rate increase.

(China’s central bank raised its benchmark interest rate today,  April 5. But that’s part of a cycle (four increases since October) of interest rate increases in China. A move by the European Central Bank would announce the beginning of a new cycle of interest rate increases in the world’s developed economies.)

The European Central Bank may feel it doesn’t have a choice because inflation climbed to 2.6% in March, well above the bank’s target of “less than but close to 2%.”

But the move is fraught with risk. Stress tests last week showed that Ireland’s banks need an additional $34 billion in capital and even before any interest rate increase the troubled economies of Portugal and Greece were forecast to contract this year. Slower economic growth and higher interest rates will make it even tougher for those countries to reduce their budget deficits as promised in 2011.

And raising interest rates does nothing to help the European Central Bank end support for the weakest banks in Ireland, Greece, and Portugal. The central bank has propped up banks in those countries with an offer of unlimited liquidity. In the aftermath of Ireland’s stress test, for example, the bank said it would keep providing credit to Ireland’s banks and would waive its minimum credit quality requirement for collateral for such loans.

Investors looking for some clarity in the minutes released today, April 5, to the March 5 meeting of the Federal Reserve released for clues on how quickly the U.S. central bank might follow the European Central Bank in raising interest rates instead got a picture of a bank divided about how big a danger inflation is now, and how and when to end the bank’s program of bond buying known as QE2 (Quantitative Easing 2.)

 

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