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Last Updated: Thursday, 1 December 2005, 12:48 GMT
Q&A: ECB interest rate rise
ECB President Jean-Claude Trichet
Mr Trichet wants to get tough on inflation
The European Central Bank (ECB) has raised interest rates by a quarter of a percentage point to 2.25% - the first change in rates for two years.

The move comes amid fears of rising inflation in the eurozone because of higher oil prices.

But many politicians in the larger eurozone countries such as France and Germany worry that the decision will slow any economic recovery.

BBC News explains the background to the ECB decision and the likely consequences for eurozone consumers.

Why has the ECB decided to raise interest rates?

The bank has decided to raise interest rates because of its fear that inflation is about to take off.

When the ECB was set up, there was a good deal of worry about high rates of inflation, and it was given an explicit mandate to keep a low and stable inflation rate.

The ECB has defined its target as keeping inflation in the 12 countries of the eurozone under 2%, but for most of the past year the inflation rate has been higher than this.

In addition, rate rises in other countries, notably the US, mean that the 2% interest rates in the ECB have been looking quite low, and as a result many investors have been moving their money into the US, weakening the euro currency against the dollar.

This could add inflationary pressures in the future, especially as oil is priced in dollars, although a cheaper currency also helps European exporters.

How much of a worry is inflation?

There are concerns that inflation is rising in the eurozone, fuelled by rising oil prices.

However, the latest figure for November show that eurozone inflation was down slightly to 2.4%, compared with 2.6% in September.

But the ECB is expected to say that it expects core inflation to rise to 1.7% in 2006 and 2.1% in 2007.

This is partly based on the ECB's use of monetary aggregates, such as M3, which measure the volume of money and lending in the economy, to forecast the future course of inflation.

This is not an approach widely used by other central banks.

What will be the effect on growth in the eurozone?

Many European politicians are worried that the rise in interest rates could choke off a potential European economic recovery after several years of weak growth and high unemployment.

These fears are particularly strong in the eurozone's largest economies: France, Germany and Italy.

The independent think-tank, the OECD, said any change to interest rates across the 12-nation bloc should wait until the middle of next year, when economic growth had recovered.

It forecast that eurozone growth could rise to 2.1% in 2006 from 1.4% in 2005.

One problem is that while there is weak growth in the core eurozone economies, growth and inflation are stronger in more peripheral countries such as Spain.

Will there be further rate rises?

The President of the European Central Bank, Jean-Claude Trichet, was at pains to tell politicians last week that they should not assume that just because the ECB raises interest rates this time, it will do it again.

However, financial markets are firmly of the belief that eurozone interest rates will continue to rise, with forward markets pricing in a rise to 2.75% by the end of 2006.

Some commentators believe that rates will go above 3% - which would still leave eurozone rates well below those of the US, which are already at 4%.

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