Storm in a teacup

Eurozone interest rate kept at 7-year high

The ECB’s decision making process may come as a surprise

As the eurozone teeters on the brink of recession the European Central Bank (ECB) decided on Thursday to leave interest rates unchanged at 4.25%. Putting their decision to one side for a moment, the very fact that the ECB’s Governing Council which includes 15 national bank governors does not actually take a vote on this important issue at their regular meetings may come as a surprise to many. Cynics may describe this as typical ‘centralised European non-accountability’ as the decision to increase, decrease or simply leave rates the same is reached by forming a ‘consensus of opinion’.
Commenting on this matter in a recent paper Willem Buiter, the Professor of European Political Economy of the London School of Economics and Political Science, said that ‘since they don’t vote they can not of course publish either the aggregate vote or the individual votes.’ He goes on to say that ‘the mystical process through which this consensus is achieved can only be guessed at.’
However their decision is reached it has widespread repercussions for everyone living in the eurozone and for those that invest within it. Homeowners and businesses hope for lower rates while by contrast savers pray for higher returns on their cash accounts!
Despite some desperate calls for a rate reduction in order to re-stimulate the region’s investment markets, house prices and economic growth prospects it was widely expected that the ECB would leave the eurozone interest rate unchanged as it believes this to be the best weapon against their greatest fear, inflation.
Another fact which tipped the scales in favour of leaving interest rates unchanged was based upon the ECB’s decision to raise interest rates back in July. For if they were to cut interest rates only two months later this would have surely raised more questions on how such a decision was actually reached and would probably have also called into question the actual credibility of the bank.
A pressing problem for ECB President Jean-Claude Trichet remains the growing demand in Europe for higher wages to counter rising food and energy costs as demonstrated by Germany’s biggest Union IG Metall which has over 3 million members and who are now preparing a demand for an inflation busting 6.5% pay increase. Mr Trichet is fully aware that if wage growth accelerates core inflation is likely to rise as a result. So far, intense competition in manufacturing has helped keep costs down for the end consumer and the recent fall in oil prices has also relieved some of the immediate pressure but inflation in the eurozone still remains way above their 2% per annum target.
So, while Mr Trichet sat with his colleagues in Frankfurt’s ‘Eurotower’ swirling the end of their drinks and contemplating the future, the outside economic turbulence was likely only to have been seen as a short-term ‘storm in a tea cup’ and a distraction away from fighting their real fear, the threat of uncontrollable inflation. The ECB is unlikely to consider cutting rates until at least the end of the year in the hope that just like Hurricane Gustav the current economic storm will just slowly subside away.

Mark Lamb is Director of FPC Investment Consultants marklamb@fpc.com.mt

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MaltaToday News
07 September 2008

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