Interest rates to increase in wake of German and French defiance

THE de facto smashing of the stability and growth pact early yesterday morning will result in a rise in interest rates as the European Central Bank (ECB) warned of serious dangers following the move.

Commenting on the decision of EU Finance Ministers (ECOFIN) not to impose sanctions on France and Germany for allowing their budgets to exceed 3% of GDP, the ECB Governing Council said: "The conclusions adopted by the ECOFIN Council carry serious dangers.

"The failure to go along with the rules and procedures foreseen in the Stability and Growth Pact risks undermining the credibility of the institutional framework and the confidence in sound public finances of Member States across the euro area.

"The Governing Council takes note of the commitments by France and Germany to correct their excessive deficits as rapidly as possible and at the latest by 2005 and strongly urges the governments concerned to live up to their responsibilities.

"It is now absolutely imperative that effective action be taken to limit negative effects on confidence.

"The public can rest assured that the Governing Council remains staunchly committed to maintaining price stability."

Ulster Bank economist Niall Dunne sees good and bad in the ECOFIN move.

"By effectively dismantling the pact as we know it, France and Germany will be able to spend more to fuel their economic recoveries over the next two years. By imposing fines, ECOFIN would have only hit them while they were down. But enter the ECB, who are not at all happy.

"Remember, the ECB is mandated to keep eurozone inflation to a 2% target, and if the euro area 12 can now spend with abandon, then inflation is going to rise.

"And that could force the ECB to raise rates in the very short term. So yes, there are positives to this news Europe's recovery can continue but it may well lead to higher interest rates, sooner than expected.

"On balance, I think that reform is a good thing; I only hope that the growth it generates is strong enough to cope with the higher rates it will inevitably bring," he said yesterday.

ECB President Jean-Claude Trichet had warned publicly against any further loosening of the rules, and diplomats said he argued against the move during the meeting.

ECB council member Nikos Garganas said: "Today's interest rates aren't expected to rise any time soon.

"It is imperative that the stability pact rules be maintained, otherwise it will put the cohesion of monetary union at risk."