European Central Bank raises interest rates, signals more increases to come: expect dollar to fall and commodities to climb

04/07/2011 12:25 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

No surprise in the interest rate increase. This morning the European Central Bank raised its benchmark interest rate to 1.25% from 1.00%.

Something of a surprise in European Central Bank President Jean-Claude Trichet’s remarks to reporters. The central bank’s monetary policy is still accommodative, he said, and while “we did not decide it was the first in a series of interest-rate increases, you know from our own doctrine that we always do what is necessary to deliver price stability over the medium term.”

The increase in the benchmark interest rate is the first since July 2008. It comes after inflation climbed to an annual rate of 2.6% in March. That’s well above the bank’s target of less than but close to 2% inflation.

The financial markets are now looking for another interest rate increase in a month or two and for two or more increases to 1.75% by the end of 2011.

The European Central Bank almost never moves to raise interest rates ahead of the U.S. Federal Reserve. In fact this is the first time that the bank has raised interest rates ahead of the Fed in 40 years. Today’s move from the European Central Bank highlights how isolated the Fed is on inflation policies and interest rates—the European Union, India, Poland, Brazil, and China have now all raised interest rates.

The increase in interest rates was so fully anticipated by financial markets that the euro fell against the dollar after Trichet’s comments to $1.41258 from $1.4291. But in the medium term, the prospects of further interest rate increases from the European Central Bank will push the euro up against the dollar. That’s likely to keep commodity—especially oil--and gold prices headed higher.

 

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