ECB, BOE Elect to Keep Interest Rates Steady

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Includes: FXB, IEV
by: Markham Lee

The ECB and the BoE have both elected to keep interest rates steady, despite growing concerns about the U.S. mortgage crisis, the credit crisis and slowing economic growth. The basic message from both banks is that fighting inflation is their key focus and their overall approach will be to take a cautious, measured approach to evaluating economic conditions and setting fiscal policy. I agree with the current approach of both the ECB and the BoE, as while reactionary changes may calm the markets and provide short-term benefits, they’re not necessarily synergistic with a central bank’s key mission of enabling long-term economic growth and stability,

Some politicians in the Eurozone have expressed concern about the rising value of the Euro impacting companies in their respective countries, indicating a degree of political pressure to cut rates. Whilst the ECB has indicated that it’s at least open to rate cuts in the future, it doesn’t appear the president of the ECB is one who will be easily swayed by political pressure.

From Bloomberg:

European Central Bank President Jean- Claude Trichet signaled the bank is in no rush to raise interest rates as higher credit costs threaten to slow economic growth.

"It remains necessary to gather additional information and examine new data before drawing further conclusions for monetary policy,'' Trichet said at a press conference in Vienna today, two weeks after the U.S. Federal Reserve cut interest rates. Trichet dropped a phrase used in previous months that the ECB's monetary policy ``is still on the accommodative side,'' suggesting the bank no longer considers interest rates are boosting economic growth.

Europe's economy is now showing signs of slowing as rising credit costs start hurt consumers and companies. Euro-region service industries from insurers to airlines grew at the weakest pace in two years in September. U.K. house prices, which have tripled in the last decade and powered economic growth over the period, fell for the first time in nine months in September, HBOS Plc said today…

[…]

Politicians including Italian Prime Minister Romano Prodi and his Luxembourg counterpart Jean-Claude Juncker have expressed concern that the stronger euro will curb economic expansion by making exports more expensive. Trichet countered by urging them to show ``verbal discipline'' when discussing the euro and refused to signal increased concern about its climb.

Show “verbal discipline” eh? Ouch.

In the U.K., there are concerns about an unfolding banking crisis, as well as a potential mortgage/real estate crisis, as housing prices did in fact decline over the past month. In fact, the British retailers association as well as Ernst and Young have both expressed support for the BoE to cut rates, with the latter claiming it would be the “smartest move for the economy”.

From the Telegraph:

The Bank of England has resisted increasing pressure to cut interest rates as policy makers take more time to assess the impact of the credit crunch on the broader economy

The decision by the Bank's Monetary Policy Committee to leave the cost of borrowing at 5.75pc was predicted by all but one of the 60 economists surveyed by financial news agency Bloomberg.

Governor Mervyn King has come under heavy fire for his handling of last month's Northern Rock crisis, which has dented consumer confidence and called into doubt the Bank's earlier projection that rates would need to rise to 6pc.

While the members of the MPC are taking more time to examine the impact of the financial turmoil on the rest of the economy, housing data today from the Halifax suggests the market is slowing. Prices dropped 0.6pc last month, the first decline this year as both buyers and sellers stood back from the market.

The Bank had indicated in its quarterly Inflation Report in August that rates might have to rise keep inflation on track, but since then the CPI has dropped and the economy has been beset by profound threats.

Today's decision to leave rate on hold will come as a disappointment to the British Retail Consortium. Kevin Hawkins, its director general, yesterday called for the bank to take immediate action on rates.

The plea from the country's retailers comes after a warning from the Ernst & Young Item Club over the weekend that a cut would be the smartest move for the economy and the struggling financial services sector.

It will be interesting to see how this plays out as both the ECB and the BOE are under pressure to cut interest rates and economic conditions may force them to in the near future. If the BoE cuts rates I suspect it will be due to a combination mortgage/banking crisis in Britain; whilst the declining dollar may force the ECB to cut rates, due to the pain a rising Euro may inflict on Eurozone companies.

Sources:

Bloomberg: “Trichet Signals Interest-Rate Pause on Credit Rout” - Gabi Thesing and John Fraher, October 4, 2007

The Telegraph: “BoE leaves interest rates at 5.75pc” – Richard Blackden, October 4, 2007

Disclosure: the Author invests in both the Euro and the British Pound.