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European Central Bank holds rates steady

The European Central Bank left its key interest rate at 2 percent Thursday in a widely expected decision.
/ Source: The Associated Press

The European Central Bank left rates unchanged Thursday as bank President Jean-Claude Trichet issued a warning that higher oil prices threaten to worsen inflation.

Trichet said that the current refinancing rate of 2 percent, unchanged for more than two years, was low enough to support Europe’s tentative economic recovery.

The bank raised its inflation forecast and cut its growth outlook for the 12 countries that use the euro currency.

Inflation risks “have been augmented not only, I have to say, by the price of oil but by the price of oil commodities and that we have to remain permanently vigilant against second-round effects.”

Second-round effects happen when expectations of price increases are built into wage and price agreements in an inflationary spiral — worse than simple price spikes from temporarily higher fuel prices due to one-time events such as Hurricane Katrina.

The bank increased its inflation projection for 2006 to 1.4-2.4 percent from 0.9-2.1 percent. The growth projection for this year dipped to 1.0-1.6 percent, and for 2006 to 1.3-2.3 percent from 1.5-2.5 percent.

Trichet said he was not indicating the bank’s next move would be an increase. “I am not pre-announcing a rate increase and I am not pre-announcing a rate decrease,” he said.

He expressed “profound sympathy and solidarity” with Katrina’s victims but added that “we will see what are the economic consequences and it is much to early to draw any economic consequences at this stage.”

The current refinancing rate of 2 percent has been in effect since June 2003, an indication of the uncertain economic prospects in the 12 countries that use the euro.

Higher rates are the bank’s chief tool to fight inflation, which is its main job. But higher rates can squelch growth if they are carried out at the wrong time.