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Outlook for European Interest and Inflation Rates

Rising inflation rates across Europe, and notably in France, with a 2.3% increase in February alone, are encouraging the European Central Bank (ECB) to increase the interest rates in order to counter these unanticipated levels of inflation. The bank shifted its year-long and its 2012 overall inflation projections.

The interest rate increases are aimed to signal to investors that there is a focus on controlling inflation throughout the Eurozone. The ECB is tightening economic policy as the economy rebuilds and expands. The ECB Governing Council members expressed that monetary policy as it stands is too “accommodative”, thus necessitating the higher interest rates. Further, the rising interest rates are an indication that the economy is strengthening to be able to withstand the shifts in investment that may occur as a result of the changes. Additionally, the increased interest rates are an emphasis on the bank’s credibility.

The problem of balancing stronger economies, like Germany and France, which recovered the most quickly from the financial crisis, with the countries that have required aid in the form of foreign loans or World Bank bailouts remains a challenge for the ECB.

The IMF last week increased its growth prediction for the euro region to 1.6% in 2011 and 1.8% in 2012. The ECB is also trying to emphasize that while the euro’s exchange rate dipped slightly in mid-April with announcements over Greece’s bond rankings they are confident that the sovereign debt crisis, in terms of those countries requiring bailouts, is a restricted situation.

The primary policy goal of the ECB this year is inflation control. The ECB has not explicitly indicated whether its Euribor rate will indeed increase to 1.75%, a further increase of 0.5%, but there are indications that such increases are not out of the question. There is an expected raise in the interest rate by 0.25% each quarter through the end of 2012 so that the interest rate at that juncture would be 2.75%. 

According to Business Week, investors in the European market can expect that the bank will be beginning to decrease its supply of liquidity to banks and to perhaps cut down on its bond purchase program as these two policies are not in line with the policies towards lessening dependency on the ECB by member countries.