Credit crunch: Central bank likely to raise eurozone interest rates despite downturn
The European Central Bank seems determined to raise interest rates this week, in the hope of reining in soaring inflation across the 13 member countries of the eurozone. But there are warning signs that members are facing a slowdown like the one affecting Britain.Some countries would be particularly hard hit if the central bank raises its one-size-fits-all interest rate by a quarter point to 4.25% on Thursday - the first rise for a year.
Figures out yesterday made a rate rise all but certain after inflation jumped to a 16-year high of 4% in June, mainly as a result of higher oil prices. The increase was from 3.7% in May and was greater than financial markets had been expecting.
"If there were any remaining doubts about a [0.25 percentage point] rate hike on Thursday, they can now be put to rest," said Martin van Vliet, economist at ING Financial Markets.
Germany, Europe's biggest economy and the world's largest exporter, has been growing very robustly on the back of a sizzling global economy and has shrugged off the strength of the euro, which makes exports less competitive. But other European economies such as Ireland and Spain are in the middle of full-blown housing market meltdown.
The German economy, which grew at 1.5% in the first quarter of this year, now looks in trouble. Rising petrol prices hit consumer sentiment and business confidence has turned down. Unemployment has ticked up for the first time since March 2006 and retail sales have fallen for three months in a row. Some economists think Germany may show no growth at all in the second quarter.
"Until recently the German economy was the last glimmer of hope for the eurozone economy. The powerhouse of the eurozone economy was running strong, fuelling the ECB's famous 'sound economic fundamentals'," said Carsten Brzeski, economist at ING Financial Markets.
"Now, Germany mirrors the malaise of the entire eurozone. Inflation is close to a 15-year high and a whole range of confidence indicators point to difficult times ahead."
Nevertheless, Germany goes into the slowdown with some momentum behind it. Other economies have run out of steam. The once booming Irish economy is in the middle of a housing slump which has brought it to a shuddering halt and raised talk for the first time in many years that people may again start to emigrate.
Housebuilding has plunged by two-thirds this year and employment in construction has dropped sharply. There are anecdotal reports of thousands of Polish builders heading home again.
A similar housing collapse, the result of enormous over-building in recent years and a big drop in demand, is going on in Spain. Spanish unemployment is heading rapidly towards 10% and inflation is above 5%.
France is suffering a slowdown in the housing market, with property sales down 30% this year and prices flagging. The French are panicking about the impact on purchasing power of higher food and petrol prices. Tighter credit conditions generally are undermining economic growth.
Lavinia Santovetti, economist at Lehman Brothers, said: "The euro area retained a good deal of momentum in the first quarter, with GDP expanding by 0.8% quarter-on-quarter. However, there is mounting evidence that the economy is faltering. A sharp fall in growth now looks imminent."
(http://www.guardian.co.uk/business/2008/jul/01/europeanbanks.globaleconomy/print)
aC. Sidebar
I have a simple solution to for our European neighbors and at home regarding the current stock market meltdown, stagflation, and down-hill skiing trend of the US Dollar. ECB (European Central Bank) lower your interest rate. US (Federal Reserve) raise your (our) interest rate.
Why you ask? Didn't the housing bubble start because of higher interest rates? Yes, but times have changed. Our economy, or shall I say our global economy is now concentrated on natural resources (specifically Petro - Euro-talk for petroleum) and ever-more the US dollar. The US dollar is at an all-time low and if the ECB does raise the interest rate for the euro-zone, the US dollar will only fall further.
I'm not an economist, but I have stayed at a Holiday Inn Express and read enough BusinessWeek and non-fiction novels to where I can understand the real issue at hand. The issue at hand isn't the housing market, it's not the gas and dollar stupid.
I believe, under my theory, if the ECB lowers the Euro-zone interest rate, the Euro currency will fall against the dollar, thus propping up the dollar. This will in turn lower the price of crude oil temporary because the dollar is temporary stronger than before. (Don't forget, crude oil is priced in dollars.) Please note, there is a reason for why my theory requires the Federal Reserve to act as well.
Under basic Econ-101, lower interest rates will foster demand, thus stimulating growth. In growth you tread the inflation waters. Sound economics is the balance of supply and demand, on the micro and macro levels. If the ECB were to lower the Euro-zone interest rate, demand will increase for housing and borrowing activities because of the cheaper cost of debt. Counterpoint, risk is significantly higher of inflation because now there exist excess subsequent demand and the ever-so-common point of 'not-enough-supply' to match the demand.
Thus you need the US (Federal Reserve) to raise the (or our) interest rates (both Federal Fund / Overnight Rate). We, as in everyone on Earth, live in an ever-growing economy where Nike Air Force Ones are demand in both the big and small towns of America to the big and small towns of Japan and England. Demand for Caterpiller machinery vehicles and Snap-On tools not only exist here in the states, but the European and Asian states as well. To balance out the sound global economic policy (aC's Global Economic Policy), action must be occur on both sides of the ocean.
Yes, the housing market is sucking right now and people will say raising the interest rates will incur further defaults and bankruptcies. Well, I have news for you. People who enter those stupid loans several years ago or in general who enter bad loans will still default no-matter how much you sugar-coat reality. We've seen how the Federal Reserve has lower consecutively the interest rates from last October to last March to low level that are obscene from the 1980's. I do have to say, rates in the 10% range did wonders for my savings account, but I digress. Even at historically low levels, people are still defaulting on mortgages and the banks are still writing them off to no end.
So, to all the members of the Federal Reserve Policymaking committee (FOMC), listen to your one member that voted against the majority decision during the last meeting. He was right to point out that a more aggressive action (raise not maintain rates) was needed to tame inflation. So it looks I have a Federal Reserve President (Dallas I think) on my side / theory. Raising the interest rates will keep inflation at bay and yes, it will slow demand for borrowing activities and growth, but don't forget the caveat of my theory.
When both sides of the ocean make the appropriate moves that I suggest, the action of each country will incur a positive outcome. For American, the Euro will be cheaper due to a substantial increase in the value of the dollar (due to subsequent ECB and Fed actions). American will travel back to Rome, London, and Paris again. Rick Steve's will continue his travel guide dominance with flair now that the term 'budget' will be back. With a temporary weaker Euro, American can buy more European things (i.e. VW, BMW, and authentic Swedish Bikini Team Calendars) cheaper. Yes, I know that will have an effect on American exports, but that's another discussion on global economics involving guns and butter (sarcastic DePaul Econ humor).
So that' s it. My rant about how the higher US dollar and lower Euro will not only lower crude oil prices, but also balance our economies and we can pretend that it's 1999 all over again, minus Enron and MCI-WorldCom. I'll be waiting for my Nobel Prize in Economics now.
