Europe Bank’s Interest Rate Hike Cheers Stock Investors

An interest rate increase by the European Central Bank on Thursday was met with cheers in most European stock markets--strange as it may seem.

Because the rate increase was widely expected--and European bond investors had been pushing for it--long-term yields actually fell, and that helped stocks.

The rate increase was “exactly what the bond market was looking for and that provides comfort to equities,” said Paul O’Connor, strategist at Credit Suisse First Boston.

The ECB raised its benchmark short-term rate from 2.5% to 3%. In Britain--which is not a member of the euro bloc yet--the Bank of England raised its key rate from 5.25% to 5.5%, also as expected.

The yield on the 10-year German government bond, Europe’s benchmark, fell from 5.12% to 5.02%, a six-week low.

European investors’ basic view of the rate hikes is that they’ll help keep inflation subdued--and that they are not the first of many such increases.

The ECB said as much. “The current economic climate is far more favorable” than it was earlier this year, said ECB President Wim Duisenberg.

“The balance of risks” for inflation has increased. “A timely rise” in rates “will avoid the need for a bigger rise later.”

Among Europe’s major stock markets, Britain’s FTSE-100 index rose 0.8%, Germany’s DAX index gained 1.5% and France’s CAC-40 index rose 0.5%.

But the rate increase didn’t help the value of the euro currency, which fell against the dollar and yen, touching $1.038, its lowest level in six weeks.

And that’s the problem for U.S. investors in European stocks this year: The markets themselves are up, in some cases quite strongly. But the weak euro is depressing U.S. investors’ returns when translated back into dollars.

The Bloomberg European 500 stock index is up 16.9% in euro terms this year--but up just 3.9% in U.S. dollar terms.