Threadneedle: ECB decision to raise rates to 4.25%

Head of Government Bonds at Threadneedle, Quentin Fitzsimmons comments on the European Central Bank's (ECB) rate rise: "It's no surprise that, the ECB raised its key benchmark interest rate by one quarter of a percentage point to 4.25%. This widely anticipated move came after Eurozone inflation climbed to 4.0% year-on-year in June, over double the bank's medium-term target. However, despite the move being almost universally expected, it was nevertheless somewhat controversial, as the economic background for the Eurozone begins to deteriorate.

"European politicians from France, Spain and most recently Germany have urged the ECB to take account of the worsening economy in its monetary policy. But the ECB's only remit is to manage monetary policy to control inflation - this really is the crux of the problem. On the same day that the ECB put rates up, the price of oil rose to a new all time high above $145 a barrel. It is this, and rising prices for metals and other commodities, that is currently driving inflationary pressures in the face of weaker growth.

"This situation puts the ECB in a very difficult position, as policy makers usually favour an easier money policy of lower interest rates when economies are weakening. The situation is further exacerbated by the likelihood of the euro becoming even stronger in response to the rate rise. Euro strength has already made life tougher for exporters by making the region's goods and services increasingly expensive for the rest of the world's consumers.

"Yet the growing evidence of strong price rises ties the hands of a central bank whose sole responsibility is keeping inflation under control. Jean Claude Trichet, has made it clear that his first priority is to manage this inflation to within the Bank's target range. So, whilst we see the ECB mainly using the increase as a move to keep inflation expectations in check, there is no guarantee that we won't see further interest rate hikes if inflation pressures continue to rise unchecked."