Trichet Signals Further Rate Increase as Portugal Rule Eased

European Central Bank President Jean-Claude Trichet signaled he may raise interest rates again in coming months and eased Portugal’s access to emergency funds as officials battle both faster inflation and the debt crisis.

The ECB increased its benchmark rate by 25 basis points to 1.5 percent today, the second increase in three months. The decision on Portugal came after Moody’s Investors Service sparked a renewed selloff in euro region bond markets, saying on July 5 the country may need a second bailout package.

Trichet is at odds with European leaders over how to contain the debt crisis, saying it’s up to nations to plug budget gaps and avert a sovereign default as policy makers fight price pressures. The yield on Greek, Irish and Portuguese two-year bonds all exceeded 15 percent today, reflecting investor concern that the Greek turmoil will spread across the region.

“Trichet seems to be really starting to lose his patience with governments and today just reinforced the divisions,” said Ken Wattret, chief euro-region economist at BNP Paribas SA in London. “While economically today’s interest-rate increase was certainly justified, it was also no doubt a message to politicians that the ECB means it when it says its prime mandate is to fight inflation, not fix the euro area.”

Euro Defaults

Today’s decision to raise borrowing costs was unanimous, and the ECB’s monetary policy “stance remains accommodative,” Trichet said at a briefing in Frankfurt. It is “essential recent price developments do not give rise to broad based inflation pressures over the medium term,” he said.

Investors are betting the crisis that started in Greece will overwhelm other euro nations. Credit-default swaps on Portugal jumped 94 basis points to an all-time high of 1,029 basis points today, signaling a 59 percent chance of default within five years, according to CMA prices at 2:30 p.m. in London. Swaps on Ireland signaled a 54 percent chance of default, while Greece has an 85 percent probability of failure.

Trichet said the ECB will suspend its minimum credit-rating threshold on Portuguese bonds after Moody’s lowered the country’s debt to junk. The suspension will be maintained “until further notice,” he said. This follows the ECB waiving minimum thresholds for Greek and Irish bonds.

Portuguese Plan

“The Portuguese government has approved an economic and financial adjustment program which has been negotiated with the European Commission, in liaison with us, and the International Monetary Fund,” he said. “The Governing Council has assessed the program and considers it appropriate.”

The euro erased its decline against the dollar after Trichet’s remarks and traded at $1.4346 as of 4:34 p.m. in London, little changed since yesterday. European stocks rose to a one-month high, with the Stoxx Europe 600 index surging as much as 1.2 percent to 278.01.

Trichet reiterated that the ECB remains opposed to selective default or credit events, while declining to comment on whether the ECB would use its own judgment or rely on ratings companies to determine if there is a default. He also said it’s up to governments to take decisions to tackle the fiscal crisis.

“We are not the actors,” he said. “The governments and the authorities are the actors. We are not the decision makers and we don’t want to substitute for the decision makers.”

‘Strong Message’

“Trichet gave a very strong message -- the gentleman is not for turning,” said James Nixon, chief European economist at Societe Generale in London. At the same time, “he very much kept the door open for further rate increases.”

Euro-region inflation, which was 2.7 percent in June, is likely to remain above the ECB’s 2 percent ceiling in the coming months, according to Trichet. He declined to say whether today’s decision is the beginning of a rate-hiking cycle, saying the central bank is never “pre-commited” on decisions.

Silvio Peruzzo, an economist at Royal Bank of Scotland Group Plc in London, said while Trichet’s language may hint at an increase in September, the ECB could also wait until the following month to raise borrowing costs further.

The Bank of England kept borrowing costs at 0.5 percent in London today. In Sweden, the Riksbank raised its benchmark repurchase rate to 2 percent on July 5, the seventh increase in a year. The People’s Bank of China yesterday raised key rates for the third time this year.

Slowing Growth

While leaders are still seeking ways to fight the crisis, Europe’s recovery is already losing momentum. Services and manufacturing growth slowed more than estimated in June and economic confidence weakened. In Germany, Europe’s largest economy which has powered the region’s recovery, investor sentiment dropped to a 2 1/2-year low last month.

“Recent economic data indicate some deceleration in the pace of economic growth in the second quarter” from 0.8 percent in the previous three months, Trichet said. “While the underlying momentum of economic growth in the euro area continues to be positive, uncertainty remains elevated.”

The ECB last month forecast euro-region growth to slow to 1.7 percent next year from 1.9 percent in 2011. The inflation rate may fall below its 2 percent ceiling in 2012, averaging 1.7 percent, the central bank estimated.

Trichet was a “little bit dovish on the growth outlook,” said Kornelius Purps, a fixed-income strategist at UniCredit Group in Munich. Still, “it is obvious that the ECB has further to go, there will be one more rate hike at least this year.”

(Updates with comment from economist in fourth paragraph.)
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