European Central Bank Lifts Key Rate

Interest rates in Europe may be heading higher than some investors had expected.

The European Central Bank on Thursday raised its benchmark short-term rate from 2.75% to 3% and said it would watch inflation pressures very carefully -- boosting some analysts’ expectations for another increase in October.

Separately, the Bank of England took financial markets by surprise as it lifted its benchmark rate from 4.5% to 4.75%, the first increase in two years.

The European Central Bank’s rate hike, its third this year, had been widely anticipated, but some economists had said the bank might then go on hold.

Bank President Jean-Claude Trichet, however, said at a news conference that policymakers would “continue to monitor very closely all developments so as to ensure price stability over the medium and longer term” -- language that previously has foreshadowed a rate increase two months later.

Trichet stressed that growth prospects were encouraging in the euro zone while inflation risks have been “augmented.”

In many countries, above-trend growth, falling unemployment and strong corporate profits are providing more leeway for businesses to pass on high oil prices to consumers -- something central bankers are determined to prevent, said John Calverley, chief strategist at American Express Bank in London.

“They are worried about a synchronized strength in the global economy now, which heightens inflation risks,” he said.

The European Central Bank is “moving in the right direction,” said Thorsten Polleit, chief German economist at Barclays Capital in Frankfurt. “Interest rates in big economies are still too low to avoid inflation.”

Australia’s central bank on Wednesday raised its key rate from 5.75% to 6%.

The U.S. Federal Reserve meets Tuesday, and Wall Street is divided on whether policymakers will boost their benchmark rate from 5.25% to 5.5% or pause in their credit-tightening campaign.

In Europe, stock markets ended mostly lower Thursday after the ECB’s move. The German DAX index fell 0.7%, the French CAC index lost 0.8% and the Spanish market eased 0.5%.

But British stocks were hammered by the Bank of England’s rate increase. The FTSE-100 index in London tumbled 1.6%.

The yield on 10-year British government bonds jumped to 4.73% from 4.65% on Wednesday.

Growth in Britain, Europe’s second-biggest economy, reached the fastest pace in two years last quarter, and annualized inflation of 2.5% in June was well above the central bank’s 2% target for a second month.

Analysts who believed that the Bank of England should have held rates steady cited rising unemployment and signs that many companies have kept a lid on wages to control costs.

But the bank’s policymaking panel, in a statement after the rate increase, said it judged that the boost was necessary, “with inflation likely to remain above the target for some while.”