While the move was justified by "growing upside risks" to price stability, Bonello said a cautious approach is warranted "as long as inflation expectations remain well anchored, monetary growth remains moderate, which it is, and there is no clear sign of second-round effects."

The ECB nevertheless appears set on raising rates further, with Vice President Vitor Constancio saying officials remain determined to fight inflation and Executive Board members Juergen Stark and Lorenzo Bini Smaghi saying the bank will gradually normalize borrowing costs.

Investor expectations for two more quarter-point increases in the benchmark rate this year, taking it to 1.75 percent, are "well founded," ECB council member Ewald Nowotny told Bloomberg News in Washington on April 16. Fellow council member Luc Coene said in an interview yesterday that monetary conditions "are too accommodative."

Bonello suggested the next tightening move could include a re-widening of the ECB's rate corridor to encourage interbank lending. That might involve raising the benchmark and marginal rates while leaving the deposit rate at 0.5 percent, thus increasing the penalty banks incur if they park money with the ECB overnight instead of lending to other institutions.

Eoin Treacy's view The ECB has little choice but to protect the interests of the core Eurozone, even to the potential detriment of the periphery. Economic growth in Germany and surrounding countries remains robust and the ECB is wary of wage pressures beginning to rise. Even though the central bank can do little about commodity price inflation, interest rates of 1.25% are probably inappropriate for strongly growing economies. On the other hand any hike to interest rates foists an even larger repayment burden on peripheral countries, ill prepared to pay off their already outstanding debt.

The Eurozone's core will always be the focus of ECB policy because it is their economic strength which will be required to offset continued weakness on the periphery. Voters, most recently in Finland, are increasingly voicing discontent about having to fund the bailouts of erstwhile Eurozone partners. However, what choice do they have? The answer it appears is greater tolerance for a debt restructuring. This article from Der Spiegel dated April 4th may be of interest. Here is a section:

IMF representatives told the European delegates that it was necessary to reduce Athens' debt burden, which is currently equivalent to around 150 percent of gross domestic product (GDP). Among the options that the IMF suggested are that holders of Greek debt could take a so-called haircut, maturities could be extended or interest rates on Greek sovereign debt could be reduced. All three alternatives would involve owners of Greek sovereign bonds giving up a portion of their returns.

Under the IMF plan, the Greek government is supposed to begin discussions with its creditors within the near future and inform them about the proposed debt restructuring. The IMF is currently reluctant to make its position public, however, out of fears that it could increase pressure on Portugal, which is already facing huge fiscal and political problems. Yields on Portuguese debt have soared in recent weeks as a result of concerns that Lisbon could be next in line for a European Union bailout after Greece and Ireland.

Greek and Portuguese CDS spreads have surged over the last week. Portugal is now deemed a greater risk than Ireland on this measure. Spread over Bunds Greek, Portuguese and Irish 10-year bonds also depict an increased perception of risk.

Banks in the core lent aggressively to the previously higher growth periphery prior to the debt crisis and many still have considerable exposure to those countries. A disorderly default has so far been avoided because the ECB has made liquidity available and effectively taken on a great deal of peripheral debt. This has helped stabilise the Eurozone banking sector but a restructuring would once again raise the question of bank liquidity and potentially solvency for some of the weakest.

Without the constraints of the Euro, Greek, Irish and Portuguese currencies would long since have been devalued. However within the Euro, not only is it impossible to devalue but the periphery's debt is denominated in Euro. The internal stresses on the single currency do not suggest an unencumbered appreciation. Rather, the currency has enjoyed an impressive rally against the US Dollar over the last three-months and is overbought in the short-term. Today's downward dynamic from the region of $1.45 checks the advance. Additional follow through and a sustained move below $1.40 would be required to indicate that a peak of more than very short-term significance has been reached.