Thursday, August 4, 2011

Why does the ECB need to keep its rates higher than the Fed and the Bank of England?

Both the European Central Bank (the central bank of the Eurozone17) and the Bank of England have today decided to keep their interest rates (on rhe Euro and on the Pound) stable.

But whereas the 0.5% interest rate of the BoE has been stable since the bank decided to react to the effects of the 2008 economics recession (and so has the Fed, with a 0-0.25% rate), the ECB has already raised the Euro interest rate twice this year, from the 1% it had moved to in order to address the global recession.

The situations with Italy and Spain are being addressed by various measures that are beyond the scope of this post/analysis.

The issues are:

1) Why does the ECB insist with this anti-inflation obsession? It should have lowered its interest rate back towards 1% as a policy measure to ease the tension on Greece, Portugal and Ireland as well as Italy and Spain and the whole of the Eurozone. Especially since Eurostat data released on August 2 (2 days before) showed that in June 2011 compared with May 2011, the industrial producer price index remained stable in both the Eurozone and the EU. In May prices fell by 0.2% and 0.3% respectively.

In a June 2011 - June 2010 comparison, industrial producer prices gained 5.9% in the Eurozone and 6.9% in the EU, down from 6.2% and 7.1% respectively in the May 2011 - May 2010 comparison. The Eurozone figure had peaked at 6.8% in March 2011-March 2011 and April 2011-April 2010 comparisons. Thus it was in June 2011 900 basis points below the peak. Since producer prices are an indication of the inflation (consumer prices index) a few months down the line, one can appreciate that the high annual industrial producer prices were a cause for inflation concern down the line in the Eurozone. And coupled with the inflation obsession of the ECB, the Bundesbank and a few other circles in Europe and globally, one can see why the ECB raised its rates 2 times this year. See but not fully appreciate, because those hikes had significant effects on other key socio-economic parameters, in some states more than others, but in all.

2) Which brings one to the following issue:

Why does the ECB have to offer such a premium for the Euro interest rates compared to the Pound and the USD?

It was already a premium at 1%, compared to the Pound's 0.5% and the USD/Fed's 0-0.25%, ie +50 bps to +75 to +100 bps (basis points). Now it is at +100 bps vis-a-vis the Pound and +125 to 150 bps vis-a-vis the USD!!!!

What on Earth (or in the systemics of the EU - Eurozone economy) requires such a premium, other than a premium of inflation-obsession?

Is it the cost of the absence of genuine economic and political union that translates into a Eurozone economy that lacks key elements that the US and UK economies have? Eg movement of labour? And in general the sub-performance in the functioning of the Single Market? The absence of EU or Eurozone economic policy? Tha forces the ECB to use interest rates and a premium to keep the Euro in balance with the USD and the Pound?

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Nick

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