More of the Same

8 June 2007



Eurozone Raises Interest Rates, Bank of England Holds Steady

Interest rates in Europe are on the rise, and this is bad news for the US dollar, for European manufacturers and exporters but good news for Europeans in general and for importers in particular. On Wednesday, the European Central Bank [ECB] raised interest rates for the eurozone to 4% from 3.75%. Although the Bank of England held rates at 5.5%, the consensus is they will rise to 5.75% before the summer is over. Economic growth as well as some inflation are behind the high rates.

In the eurozone, the 4% rate is the highest it’s been in 6 years, and it is a doubling of rates in the last 18 months. The ECB has increased its inflation forecast to 2% this year from 1.8%, although it has left the 2% forecast for 2008 in place. The tea-leaf readers in Europe have parsed through remarks from Jean-Claude Trichet, the ECB boss, and have decided that he’s not going to raise rates next month. After that, whatever consensus there is collapses, not over whether rates will go up again, but rather when and by how much. Targets bandied about Europe range from 4.5% to 4.75% with a couple analysts suggesting 5% isn’t out of the question.

In Britain, which wisely stayed out of the eurozone when it was formed, inflation is trending downward. April’s consumer price index was at 2.8%, down from 3.1%. However, the government’s target for inflation is 2.0%. So the question is whether 5.5% is enough to wring out another 0.8% from the CPI if the BoE does nothing further. The decision to hold steady is clearly to buy time to assess the impact of the four rate increases since August 2006. The danger is that further rate increases will push an already declining inflation rate so hard that it damages economic growth. A pause is quite in order.

Economic growth and higher interest rates attract capital. Money flows into an economy, and that means that foreigners bid up the price of the currency so they can participate in the prosperity. So, the US dollar relative to the euro and the pound sterling will face downward pressure this summer. Bad news for Yankees wanting to soak up European culture, but good news for all those New York, Florida and California retailers, whose prices will look like even bigger bargains for the gazillion European tourists on their way to the States. The only check on this that one can see is political instability. Yesterday’s test of a North Korea missile lowered the yen against the dollar but only for a while.

Meanwhile, the US housing market is slowing down (as is Britain’s, but housing prices there continue to rise about 10% annually), and consumer spending is softening. Core inflation is high (according to the Federal Open Market Committee; this journal thinks it’s a bit low given terror threats and a war in Iraq-Nam), but its rise is mitigating. So, interest rates in the US won’t be rising as soon at those in Europe. That means the future is going to be like the present but more so.

© Copyright 2007 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Fedora Linux.


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