As interest rates rose across Europe last week, equity markets soared. In contrast to what is often the received wisdom, investors decided that a higher cost of borrowing did not necessarily mean that equities should suffer. Instead, the view increasingly taken is that central bankers had done stock-market investors a service. By raising interest rates, one argument went, they were nipping in the bud any nascent signs of inflation and ensuring a stable macro-economic environment in which companies could flourish. As a consequence, European asset markets, receiving a last-minute boost from a benign set of employment data from the United States on Friday, ended the week robustly. In London, the FTSE-100 index ended up 0.4 per cent, after climbing more than 1 per cent on the day. In Germany, the benchmark Dax index rose 0.4 per cent to its highest level this year at 5,658.1 points. In France, the Paris CAC-40 ended the week with its sixth-straight record close, ending 0.65 per cent higher, to 4,975.9 points. 'It all reflects relief,' said the head of one dealing desk at a major European bank. 'Nobody likes to see higher interest rates, but they know that the alternative is worse and that one of the best ways of avoiding a sharp correction is by taking small pre-emptive measures now.' The European Central Bank raised rates across the 11-nation eurozone block by 50 basis points to 3 per cent, and the Bank of England tightened monetary policy by 25 basis points to 5.5 per cent. 'The view seems to be that central banks are doing enough to ensure that inflation remains below the ceilings set by official inflation targets and that interest rates will peak at much lower levels than has been the base in previous rate cycles,' said Brian Martin, chief currency economist at Barclays Capital. National Australia Bank's economist, Robin Aspinall, saw the market reaction as even more unambiguous. 'The message is loud and clear: the bear market in interest-rate expectations is over.' Yet there are still pockets of dissent to this near-consensus view, and concern is being expressed that the markets are overreacting to what is essentially a negative signal. 'Have markets gone mad?' asked one fund manager last week. 'In my day, when interest rates went up, shares went down. This is not good for the equity market; it is bad.' That argument says the decisions by the ECB and the Bank of England to raise rates could be harmful in the long run and are unwarranted. Indeed, if interest-rate rises are meant principally to counter inflation, then some economists ask: where are the signs of rising prices? In Britain, for example, the retail-price index is showing growth of only 2.1 per cent, well below the Bank of England's target of 2.5 per cent. Even across Europe, consumer prices have barely moved beyond 1 per cent so far this year. The British authorities might have some justification for their move. Although broad retail-price inflation remains relatively subdued, house prices - albeit mainly in London and southeastern England - are rocketing, and the fear is that it could be only a matter of time before an unsustainable property bubble bursts, causing a wealth-effect crash with dramatic impact on the economy. In contrast, the ECB has less historical precedent. Eurozone economic policy-making is only 10 months old and does not yet have the same credibility as the Bank of England's. To give some benefit of the doubt, however, one reason for increasing rates could be explained by the sharp 5.3 per cent rise seen in broad M3 money supply in the July-to-September quarter. More worrying is the possibility that there might have been no technical reason whatsoever for the ECB's decision. Some economists believe that what the ECB has achieved in its first-ever tightening of monetary policy is a significant boost to its credibility and standing in financial markets. It has shown that it is not afraid to take action, even when it is not immediately evident that action is needed. '[ECB President] Wim Duisenberg pointed out that the ECB had clearly signalled and re-signalled its thinking since July,' Mr Aspinall said. 'The ECB has its internal discussions and disagreements. The differing views often get public airing. But, in the end, the decision is a consensual one on behalf of the institution as a whole. 'After a shaky start, the ECB has found a style that is both credible and visible.' If equity markets are celebrating in Europe, it is because they have just made a new friend. The only problem is that friendship could turn sour if it is later adjudged that interest rates should never have gone up in the first place.