Financial Market

Interest rates for the Eurozone were today raised to 4.25%, the first Eurozone interest rate rise in twelve months, in a move aimed at tackling record levels of inflation which this week hit 4%.

Rising food and fuel costs resulted in the European Central Bank raising its interest rate, a move which is thought could further weaken the dollar which is currently at a two month low, and lead to further increases in the trading price of oil.

In anticipation of the ECB’s rate increase, oil hit new record highs today, with Brent crude topping $146 a barrel for the first time.

The interest rate increase comes amid concerns that the eurozone economy is slowing and there are further concerns that rate hikes could slow the economy further.

“Today’s ECB interest rate hike underlines the bank’s determination to bring inflation down, even amid plain evidence of slowing gross domestic product growth” - Jennifer McKeown from Capital Economics.

Within the eurozone it was Spain who announced figures that suggested it is heading for recession with it service sector showing significant signs of retraction.

Other leading banks have also warned that It also signalled that more interest rate rises could be on their way if world oil and food prices continued to rise.

After news last week about the FED plans to inject liquidity into financial markets through a series of below market rate inter-bank loans totalling $20 million dollars, the European Central Bank has taken further steps pumping a record 348.6 billion Euros ($502 billion) into financial markets.

The emergency move follows last weeks co-ordinated action, and resulted in short term markets rate reducing at the quickest rate for ten years on Tuesday 18th December. The amount invested by the ECB was twice the amount first indicated, and came as a result of 390 private sector banks in the eurozone requesting the emergency funds.

The funds were offered for two weeks to boost liquidity in financial markets at a rate of 4.21%, short of previous market rates and with the intention of easing tightened credit markets. The loosening of those markets will then relieve fears of a Christmas period meltdown, a time of year when banks in particular need more cash to balance increased retails spending.

The loans made available by the ECB are 25 times larger than those the Bank of England previously made available, through a series of three month credits at 5.95% totalling £10 billion.

With the ECB making funds available to banks over a short term period, the aim is that these funds will be passed onto companies and individuals at cheaper rates. Indeed on news of the ECB’s actions the short term lending rate dropped, with the two week euro libor rate falling to 4.4%.

The fact that these short term cash funds were offered at 70 basis points less than the commercial cost of short term money sends out a clear message that things are so grim in the money markets that the ECB will do anything to unblock the system.

The offering of unlimited money at below market rates by the ECB through this immense cash injection is not a magic cure, but is more a step that will tide markets over the holiday period. It seems more an admission that central banks have failed to thaw freezing money markets of the last three months, and the problem still remains more about credit worries than market liquidity.