Further ECB interest rate rises are unlikely

THE slowing eurozone economy may leave the staunch ECB governing council looking foolish before this chapter in global economic history is resolved.

But from an Irish perspective if offers some hope.

For some time it has been the case that the threat of higher ECB rates was undermining consumer confidence as the housing market stalled.

The latest economic figures coming out of Europe suggest the economy went into recession in the second quarter and is likely to stay there also in the third quarter of 2008.

In US terms two periods of contracting economic activity means recession.

To an extent that’s academic. What’s important from an Irish perspective is that it is now highly unlikely at this stage the ECB will push for further rate rises in the interim.

It would be wrong to underestimate the ECB’s resolve in that regard and since the global banking sector hit troubled times last year it has steadfastly refused to sideline the price stability issue in the interest of the bigger economic picture.

That meant there was no concession on interest rates, unlike in the US when the Fed slashed rates.

In fact how the ECB handled the credit crunch by comparison with the US is a story in itself.

European bankers made a distinction between the need to pump billions of euro into the wholesale lending market to keep the banking sector afloat and the need to restrain the level of inflation, which has been creeping up steadily, by not cutting rates in the way the US has done.

It’s also forgotten that for all the ECB’s babbling on about price stability its record on keeping inflation at its target level of just under 2% is far from good.

In a difficult economic environment, it is dealing with an inflation figure touching 4.1%, more than double its mandated level.

And it looks as if the ECB will continue to juggle with that problem if the rate of inflation refuses to come back from its current level.

Several factors including higher oil prices, nearly seven times higher than they were five or six years ago and soaring food prices, pushed up by a variety of factors have all contributed to higher prices in the eurozone over the past 12 to 18 months.

However with the credit crunch piled on top of those price issues signs are starting to appear that the euro area is finally buckling under these various pressures.

But unlike the US, the ECB’s sole task is to keep inflation under control and while that was and still is an issue, it was difficult for the ECB to cut rates with the same aplomb demonstrated by the US.

The US central bank is charged with a balancing act in that context.

Their brief is to keep inflation under control while at the same time to pitch interest rates at levels that will not hurt business and keep the consumer borrowing and spending.

In fact the Fed can be counted on to err on the side of low interest rates as they demonstrated after the dotcom bubble when rates were slashed to an historic low of 1%.

They march to a different drumbeat to the ECB in that sense.

Mindful of it being the land of opportunity, the Fed in recent crises has always backed the consumer and the economy ahead of inflationary concerns as they clearly did again in 2007 when the banking crisis erupted.

The ECB, over which the German Central Bank exerts a powerful influence, has always insisted inflation had to be the bank’s sole mission and that interest rate policy had to be set around achieving the 2% target.

That goes back to the bad days in Germany when inflation in the 1930s went totally out of control.

To an extent the whole of the eurozone is living the consequences of that grim period in Europe’s history forcing the ECB to take a different stance to the Fed over the past 12 months.

But now that Europe’s economy looks to be in recession, that should ease the pressure on interest rates.

From an Irish perspective that’s welcome news.

It will not however, mean a rapid return to growth but at least it gives a bit more assurance to prospective borrowers and should help rebuild consumer confidence.

But that will take time and in truth the cleaning up after the party is still in its very early stages.

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