As expected the European Central Bank decided to raise the interest rate by 0.25% to 1.5%; this rate decision didn’t seem to affect the financial market as the Euro/dollar continues to moderately fall. What does this decision mean to the financial markets and in particular the commodities market?
The European Central Bank convened today and decided to raise the Euro Area interest rate by 0.25 per cent point from its current level of 1.25% to 1.5%. This is the second rate hike in 2011.
One of the main reasons for this interest rate hike is related to the ongoing rising inflation: in June 2011 the annual inflation rate reached 2.7% in annual terms, which is above the ECB’s 2011 annual target inflation of 2%.
The chart above clearly shows that since mid-2009 there has been an upward trend in inflation rate after the interest rate reached a low level of 1%. Since then, the inflation started to rise. It also shows that in the last several months the inflation settled near the 2.7-2.8%.
Following the announcement of Trichet to raise the ECB rate, this decision is expected to have lagged negative effect on gold, according to Roache et. al (2008); i.e. as the ECB rate rises, gold falls the following day; in the previous rate raise back in April 13th, gold declined. Currently, gold is traded moderately up.
Since Europe is facing financial risks including the debit crisis in Greece and Portugal, it’s likely that this recent raise might even raise the demand for gold, because the recent rate hike raises the cost of Euro and consequently the cost of the loans Greece and Portugal will need to payback.
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