European Central Bank raises interest rate over inflation fears

The European Central Bank raised its benchmark interest rate Thursday as policymakers decided that battling rising inflation is more important than nurturing battered economies such as Greece, Ireland and Portugal.

On Wednesday, Portugal became the third Western European country in a year to appeal for a bailout to keep its government functioning amid high borrowing costs and weak growth.

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But the ECB, the central bank for the 17 nations that share the euro, has been caught between an ongoing recession in Europe’s “periphery” and an increasingly solid recovery that has stoked inflation worries in strong economies such as Germany.

Distinguishing itself from the U.S. Federal Reserve, whose monetary policy aims to keep interest rates very low to sustain the economic recovery and has raised concerns about inflation expectations, the ECB wants to make clear it will not let inflation take hold.

The Bank of England kept its rates the same despite an inflation rate approaching 5 percent, reasoning, like the Fed, that economic recovery remains the undisputed priority.

In its request to the European Commission, Portugal acknowledged that escalating borrowing costs and a political deadlock in the country had put it at risk of being unable to raise the funds needed to keep its government operating.

No amount was specified in the notice sent by outgoing Prime Minister Jose Socrates that the country wants to tap a trillion-dollar emergency fund established by the European Union last year to help Greece. The fund has also been used by Ireland.

European officials and outside analysts have estimated that Portugal will need as much as $100 billion.

Socrates, who resigned recently after the Portuguese parliament rejected a budget-cutting plan, which triggered new elections, said the request comes as a “last resort.”

“I tried everything, but we came to a moment that not taking this decision would bring risks we can’t afford,” Socrates said in a statement from Lisbon on Wednesday. “The government decided to make the European Commission a request for financial aid.”

A wide array of analysts expected that Portugal would need help, so the request might have little immediate impact on markets. In recent public statements, Dominique Strauss-Kahn, managing director of the International Monetary Fund, has complained that Europe is too slow in attending to its economic problems and said states needing help are better off asking for it sooner rather than later. In Portugal’s case, a looming April 15 bond issue was a potential breaking point for the country’s ability to finance its operations, with its long-term borrowing costs rising to about 10 percent, an unsustainable level.

The larger significance will be what happens next — whether world investors start wondering about the fiscal health of larger, heavily indebted European countries such as Spain, or whether Portugal acts as a fire wall whose rescue marks the end of Europe’s debt crisis and the speculation that the 17-nation euro zone may break apart.

Strauss-Kahn and outside analysts have said they think that Spain’s comparatively aggressive action over the past year to cut its budget deficit and restructure its banks has set it apart from the others.

Still, the next few weeks will form another closely watched chapter in the evolution of Europe’s economic troubles. There will be extensive talks with European officials and the IMF over what conditions Portugal will have to meet in return for the lower-interest loans that will keep the government operating while the country tries to revive its economy. The IMF will probably contribute to the Portuguese rescue, though the agency said in a statement Wednesday that it had not been asked for assistance. Spanish banks also have major investments in Portugal, raising the risk that the economic problems could spill across the border.

In Portugal’s case, efforts to rekindle growth will be critical. Greece and Ireland succumbed to different problems: Greece to a massive overload of public debt that it could not afford, and Ireland to commitments made by the government to back up the country’s banks even as a collapsing real estate market prompted escalating bank losses.

Portugal, however, has been hobbled largely by an economy that never kept pace with the other nations in the euro zone monetary union. It wed itself, for example, to an economic strategy that focused on lower-wage manufacturing even as those types of jobs were shifting rapidly to Asian nations such as Vietnam and China.

Portuguese officials had hoped to manage the problems on their own, but as the interest rate demanded by investors heightened in recent days, so did pressure on the government to act.

The European Central Bank has spent tens of billions of dollars over the past year buying the bonds of troubled European countries and lending money to keep its weaker banks afloat, programs that ECB officials are eager to phase out. At the same time, the bank, designed to keep a singular focus on inflation, is expected to begin raising interest rates this week to combat rising prices — a particular concern in Germany, the bank’s most influential member.

That will work against recovery in weaker nations, another reason for Portugal to seek outside help.

Portuguese Finance Minister Teixeira dos Santos, in a written response to local newspaper Jornal de Negocios, said that Portugal was “irresponsibly pushed” by bond investors to seek outside help but that the country’s political parties would now have to agree on budget, tax and economic changes to satisfy European and IMF demands.

 
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