ECB ups rate to 4.25%

The ECB's Governing Council, meeting in Frankfurt, increased the benchmark lending rate by a quarter point to 4.25 per cent yesterday, as predicted by all but one of 58 economists in a Bloomberg survey.

Policy makers said they're worried the fastest inflation in 16 years will develop into a wage-price spiral as workers demand more pay to compensate for rising costs. The risk is that higher interest rates deepen Europe's economic downturn. France and Spain have already said that the ECB may not be paying enough attention to the growth outlook.

"The ECB is choosing the lesser of two evils," said Rainer Guntermann, an economist at Dresdner Kleinwort in Frankfurt. "We fear that oil prices and inflation will create the need to raise interest rates further."

Investors have fully priced in another quarter-point rate increase to 4.5 per cent by the end of the year and most expect a third step by March, Eonia swap contracts show.