Analysts: Eurozone rate hike to hurt Spain

April 7, 2011 at 3:00 AM
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BRUSSELS, April 7 (UPI) -- Rising interest rates could hurt Spain, laden with debt and facing sovereign default, analysts said after Portugal sought a bailout.

A rate increase such as one the European Central Bank is expected to make Thursday "will hurt the periphery," including Spain, exerting "pain on the Spanish economy and consumers," Royal Bank of Scotland senior European economist Nick Matthews said.

"About 80 percent of Spanish mortgages are set with variable rates, so an ECB tightening is going to hit these people hard," he said in a statement quoted by the Financial Times.

"Rate rises have come at the wrong time for Spain," said sovereign risk analyst Nick Spiro of London's Spiro Sovereign Strategy Ltd.

"In our view, this would dramatically increase the risk of more debt trauma ... and a hard-landing scenario for the eurozone as a whole," Chief Economist Michael Darda of MKM Partners LLC of Stamford, Conn., said in a note to clients.

The ECB is set to raise its benchmark short-term rate to 1.25 percent Thursday from a record low 1 percent -- the first increase since July 2008. The expected move follows ECB President Jean-Claude Trichet's March warning the bank's Governing Council eyed inflation pressures with "strong vigilance," a phrase previously signaling tighter monetary policy.

The bank is to announce its rate decision at 1:45 p.m. Frankfurt time (7:45 a.m. EDT). Trichet is to hold a news conference 45 minutes later.

Many analysts said the bank, which administers the 17 European Union eurozone member states' monetary policy, would probably increase rates twice more this year to 1.75 percent.

Inflation for the EU states that use the euro as their common currency and sole legal tender rose above the ECB's 2 percent target rate in December and hit 2.6 percent last month, the fastest pace in more than two years.

Because interest rates and the inflation rate tend to be inversely related, if inflation is above the target, central banks often raise interest rates to cool the economy and bring inflation down.

China, India, Poland and Sweden have already raised interest rates. The Bank of England and Bank of Japan are expected Thursday to keep their benchmark rates at 0.5 percent and 0.1 percent, respectively.

The U.S. Federal Reserve has kept rates near zero despite signs of a pickup in U.S. economic growth. Several members of the Federal Open Market Committee, which sets monetary policy, said last month the Fed might keep rates at historic lows beyond this year.

The committee viewed the chances of faster economic growth, and the risk of a slowdown, as "roughly balanced," minutes from the meeting indicated.

Portugal is the third eurozone nation, after Greece and Ireland, to turn to its peers for help. It is expected to get aid from EU bailout funds and the International Monetary Fund.

"It is time to assume the responsibility to the country," Prime Minister Jose Socrates said in a nationally televised speech Wednesday night. "It is in the name of national interest that I tell the Portuguese people that we need to take this step."

The country is viewed as a firewall between small economies whose bailouts are painful but manageable and large economies, like Spain's, "whose infection would set the [sovereign-debt] crisis on a far darker course," The Wall Street Journal said.

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