The European Central Bank may hike interest rates next month, far earlier than markets expected, though any rise would not signal a series of increases, President Jean-Claude Trichet said on Thursday.
The strong indication that a rise will come in April shocked markets expecting a raise late this year and put the ECB in pole position to hike well before the U.S. Federal Reserve and even the Bank of England, which analysts had expected to move first.
The position of the Governing Council is that an increase in interest rates at the next meeting is possible, Trichet told a news conference after the central bank left rates at a record low 1.0 percent.
He dismissed the idea that a rate rise in April could be bigger than 25 basis points, saying such a scenario was not the appropriate interpretation.
The euro soared as Trichet spoke to as high as $1.3976, its strongest since November 8, putting it on track to test the psychologically important $1.40 level.
He certainly went 90 percent of the way to announcing a hike to come in April and certainly caught the market by surprise, said Peter Schaffrik, strategist at RBC Capital Markets.
It looks like they're going to hike rates in April, that's as close to a done deal that you can get from a central bank, Schaffrik said. Afterwards, there's probably more hikes to come at some stage, how quick that's going to be is uncertain.
Asked whether a potential rate rise in April would signal the start of a round of hikes, Trichet said: It is certainly not the sense of the start of a series of rate hike increases.
Trichet said the ECB would exercise strong vigilance over rising inflation, deploying a phrase that in the past signaled a rate rise was only a month away.
Strong vigilance is warranted with a view to containing upside risks to price stability, he said.
The ECB used the phrase repeatedly during its 2005-2007 rate hike cycle, typically one month before it raised rates, although there were exceptions to that rule. Trichet said an April rate rise was not certain but sounded notably hawkish.
When we have a shock -- and we have a shock -- our responsibility is to prevent a second round of effects (from high oil prices), he said.
In his opening statement, he also pointedly did not say that rates were at an appropriate level, saying price pressures had increased since the ECB last met a month ago, largely due to a rise in commodity prices, and that risks were on the upside.
Euro zone inflation accelerated to 2.4 percent last month, moving further above the ECB's target of just below 2 percent.
In a fresh set of forecasts, ECB staff forecast euro zone inflation would overshoot the central bank's target this year, but to fall back to below the 2 percent upper limit in 2012.
Trichet said staff expected inflation to be 2.0-2.6 percent in 2011 and between 1.0 and 2.4 percent in 2012, for a mid-point of 1.7 percent that year.
Trichet also said the central bank would carry on providing unlimited funding for banks at its three-month operations for the next three months and would keep full allotment at its weekly and one-month operations, until at least July 12.
By signaling its readiness to raise rates while keeping support in place for banks, the ECB tailored its policy to address growing inflation pressures while keeping in place measures to help lenders in weak peripheral euro zone states.
Winding down the support measures could have left banks in peripheral countries like Portugal in a squeeze if EU leaders fail to come up with a comprehensive package to tackle the euro zone's sovereign debt crisis at their March 24/25 summit.
A weak deal at the summit could turn markets more negative on the bloc's peripheral countries, further delaying the central bank's exit from crisis liquidity measures.
German resistance to boosting the rescue fund has heightened uncertainty about the summit outcome.
Trichet has called for European leaders to give the rescue fund, the European Financial Stability Facility (EFSF), maximum flexibility in both size and scope.
It's increasingly clear that on March 25 we'll have some kind of result but probably not the comprehensive solution that was hoped for, said Deutsche Bank economist Gilles Moec.
The ECB's head of market operations Francesco Papadia said earlier on Thursday money markets were polarized, with banks in the periphery still dependent on the ECB for liquidity.
(Additional reporting by Paul Carrel and Sakari Suoninen) (Editing by Mike Peacock)