The euro jumped to a four-month high Thursday after the head of the European Central Bank surprised markets by saying interest rates could be raised as soon as the next policy meeting in April, far earlier than expected.
The euro was up .92 a cent to $1.3958 US in the late afternoon, after trading as high as $1.3974, matching its November levels.
Speaking after the bank left its main interest rate unchanged at the record low of one per cent, president Jean-Claude Trichet said "strong vigilance" was warranted and that an interest rate increase next month was "possible" though "not certain."
"It is paramount that the rise in inflation does not lead to second-round effects and thereby give rise to broad-based inflationary pressures over the medium term," said Trichet.
By second-round effects, Trichet was referring to wage increases, which threaten to embed high inflation in an economy.
Most analysts weren't expecting a rate increase until later this year, partly because a number of countries in the euro zone, such as Greece, Ireland and Portugal, are trying to contain a government debt crisis that involves slashing spending and raising taxes.
"The market had expected Trichet to use some finesse in his hawkish remarks today — he used a sledgehammer," said Michael Woolfolk, senior currency strategist at Bank of New York Mellon. "Today's comments are truly remarkable."
Trichet dismissed the notion of a big rate increase — one of more than a quarter point — as "not appropriate."
'He used a sledgehammer.' —Michael Woolfolk, Bank of New York Mellon currency strategist
He also sought to downplay any suggestions that an April interest rate rise would necessarily lead to more rises over the months ahead. "It is certainly not the sense of the start of a series of rate hike increases," he said.
Marie Diron, a senior economic adviser to accounting firm Ernst & Young, said a premature ECB rate rise as a response to an energy-fueled price spike would be a "policy mistake."
The ECB's only mandate is to control inflation — unlike the U.S. Federal Reserve, which also has to keep a close watch on the wider U.S. economy, in particular the labour market.
In the last 12 months, higher food and energy costs have pushed consumer price inflation in the euro zone up to 2.4 per cent — above the ECB's target of "close to but below" two per cent.
The ECB also released forecasts that show inflationary pressures have swelled since the last estimates in December and are now expected to be between 2.0 per cent and 2.6 per cent in 2011 and between 1.0 per cent and 2.4 per cent in 2012.
Trichet cautioned that the forecasts were made before the latest spike in crude prices due to the tensions in Libya.