As expected the ECB raised its interest rate to 1.5% – July 7

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 to US 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 percent 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 rate: 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 below shows the changes in interest rate and EURO inflation rate since January 2008.

 CPI EURO AREA 2010-2011 (Y-2-Y) & Basic Interest Rate of ECB JULY 07

 The chart clearly shows that since mid-2009 there has been an upward trend in Euro Area inflation rate after the interest rate reached a low level of 1%. Since then, the European Union inflation rate started to rise. It also shows that in the last several months the inflation rate 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 price, according to Roache et. al (2008)*, even when controlling for the effect this news might have on US dollar; i.e. as the ECB rate rises, gold price falls the following day; in the previous rate raise back in April 13th, gold price declined. Currently, gold price 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.

*These correlations are based on the research done by Roache et. al (2008) in the paper named “the effects of economic news on commodity prices: is gold just another commodity?”


The financial market didn’t show much reaction to the news as the Euro moderately depreciated against the US dollar.

Current gold price, short term futures (August 2011 delivery) is traded at $1,529.4 per t oz. a $0.2 increase or 0.01%, as of 14:28*.

Current Nymex crude oil price, short term futures (August 2011 delivery) is traded up by 1.82%, at $98.41 per barrel as of 14:27*.

Euros to USD is currently traded down at 1.4293 a 0.1844% decrease as of 14:38*.

(* GMT)


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