Today, the European Central Bank did what it hinted last month that it would do, namely raise its main interest rate by a quarter of a percentage point to 1.25%. This is the bank’s first increase since 2008 when downward interest rate movements started. Their rationale, as with other Central Bankers around the world in such circumstances, is to use such a rise to counter the prospect of overheating inflation within the Eurozone. Such inflation is mainly due to the rise in commodity prices such as oil which is needed to fuel the recovery, if you will forgive the pun. The ECB’s target inflation level is to be below or close to 2%. March’s inflation rate was 2.6%.
While this move is not helpful to the debt problems facing Ireland, Portugal, Greece and Spain it is needed in the broader European context. The fact that such an upward movement, with more to come, was anticipated by markets is what has underpinned its mainly highest position over the last 12 months against both Sterling and the US Dollar, the currencies of two of our main trading partners. The upshot is that exporters, the businesses that we need to kickstart our recovery, are either hamstrung, or will be, by a too strong currency and an increasing interest rate base.
Of course the rise also impacts on home owners that are, in many cases, mortgaged to the hilt following the over-exuberance of the Celtic Tiger, now mangey moggy. Whatever struggles such homeowners were experiencing before now will be exasperated further with higher mortgage repayments. Further personal belt tightening is needed which, in turn, will restrict consumer spending in these countries. This is unfortunately the opposite of what struggling businesses in the PIGS environment need right now. It will be a slow and tortuous way forward for the next 2 years!