A gulf opened up between Europe's two largest central banks yesterday after the Bank of England responded to the global credit squeeze by cutting interest rates while the European Central Bank (ECB) indicated another increase was still on the agenda.
The Bank of England cut its main interest rate by a quarter of a percentage point to 5.5 per cent, reflecting its concern that the medium-term economic outlook had darkened in recent weeks.
It blamed deteriorating conditions in financial markets and "a tightening in the supply of credit to households and businesses" that threatened to depress growth and allow inflation to fall too far below the bank's 2 per cent target.
The ECB refused to be swayed by cuts in US and British interest rates, revealing that it had even considered raising euro-zone borrowing costs as part of a strategy of talking tough to combat high inflation.
ECB president Jean-Claude Trichet said "some" members of the bank's 19-strong governing council had favoured an interest rate rise at a meeting in Frankfurt.
But the ECB's main rate had been left unchanged at 4 per cent because of the uncertain macroeconomic impact of "still-evolving" financial market developments.
The unexpectedly hardline stance - though dismissed as bluster by some in financial markets - pointed to a split on the council, with at least a minority fearing losing control of inflation and unimpressed by the threat of a significant economic slowdown ahead.
Euro-zone inflation hit a six-year high of 3 per cent in November. Updated ECB forecasts showed euro-zone inflation rising to a range with a mid-point of 2.5 per cent this year - well above its target of an annual rate "below but close" to 2 per cent - before falling to 1.8 per cent in 2008.
Mr Trichet said inflation was the sole "needle in our compass", underlining the central bank's determination not to use its main interest rate policy to bail out financial markets.
Increasing or holding rates were the only options considered, he said, making clear that a cut was not on the ECB's agenda.
The stance suggested that a significant deterioration in growth prospects and inflationary pressures would be needed before a reduction in interest rates was considered. "History suggests that the economy has to be at a virtual standstill for the ECB to cut rates," said Ken Wattret, economist at BNP Paribas.
The ECB's optimism would have been boosted by data for German industrial orders showing a 4 per cent leap in October, with growth especially strong in export orders. That suggested industry in Europe's largest economy had brushed off the effects of a strong euro.
The Bank of England admitted it was still worried about rising inflation over the next few months, but it judged the risks to the wider economy justified the easing.
